Case 7 • Starbucks Coffee: Expansion in Asia • 655
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C ASE 7
STARBUCKS COFFEE: EXPANSION IN ASIA
HISTORY
Starbucks Coffee Company was founded in 1971 by three
coffee aficionados. Starbucks, named after the coffee-loving
first mate in Moby Dick, opened its first store in Seattle’s Pike
Place Public Market. During this time, most coffee was pur-
chased in a can directly from supermarket shelves. Starbucks’
concept of selling fresh-roasted whole beans in a specialty
store was a revolutionary idea.
In 1987, Howard Schultz, a former Starbucks employee,
acquired the company. When Schultz first joined Starbucks in
the early 1980s as director of retail operations, Starbucks was
a local, highly respected roaster and retailer of whole bean
and ground coffees. A business trip to Milan’s famous coffee
shops in 1983 opened Schultz’s eyes to the rich tradition of
the espresso beverage. Schultz recalls, ‘‘What I saw was the
unique relationship that the Italian people had with the ubiq-
uitous coffee bars around Italy. People used the local coffee
bar as the third place from home and work. What I wanted
to try and do was re-create that in North America.’’ Inspired
by the Italian espresso bars, Schultz convinced executives to
have Starbucks’ stores serve coffee by the cup. And the rest is
history! The company has seen phenomenal growth from 17
coffee outlets in Seattle almost 35 years back to 9000 shops in
around 28 countries worldwide.
Starbucks went public in 1993 and has done extremely well
in turning an everyday beverage into a premium product. The
green and white mermaid logo is widely recognized; the brand
is defined not only by its products, but also by attitude. Busi-
ness Week’s most recent survey (2004) of the top global brands
reported Starbucks as one of the fastest growing brands with
a cult following. It is all about the Starbucks experience, the
atmosphere, and the place that is a refuge for most people to
get away from everyday stresses. The average customer visits
a Starbucks 18 times in a month, and about 10 percent of all
customers visit twice a day. Starbucks has created an affinity
with customers that is almost cult-like. Today, Starbucks is
the leading roaster and retailer of specialty coffee in North
America, with more than 1000 retail stores in 35 markets.
MISSION STATEMENT
Starbucks’ corporate mission statement is as follows: ‘‘Estab-
lish Starbucks as the premier purveyor of the finest coffee
in the world, while maintaining our uncompromising princi-
ples as we grow. The following guiding principles will help us
measure the appropriateness of our decisions:
1. Provide a great work environment and treat each other
with respect and dignity.
This case was prepared by Valerie Darguste, Ana Su, Ai-Lin Tu, and
Peggy Wei of Stern School of Business at New York University and
updated by Sonia Ketkar of the Fox School of Business and Management
at Temple University under the supervision of Professor Masaaki Kotabe
for class discussion rather than to illustrate either effective or ineffective
management of a situation described (2006).
2. Apply the highest standards of excellence to the purchasing,
roasting, and fresh delivery of our coffee.
3. Develop enthusiastically satisfied customers all of the time.
4. Contribute positively to our communities and our environ-
ment.
5. Recognize that profitability is essential to our future suc-
cess.
6. Embrace diversity as an essential component in the way we
do business.
Starbucks’ corporate objective to is become the most rec-
ognized and respected brand of coffee in the world. To achieve
this goal, Starbucks plans to continue to expand its retail oper-
ations rapidly in two ways: first, to increase its market share in
existing markets, and second, to open stores in new markets.
In 2004 alone, Starbucks opened 4 stores a day on average.
Starbucks’ retail objective is to become a leading retailer and
coffee brand in each of its target markets by selling first-quality
coffees and related products. In addition, Starbucks provides
a superior level of customer service, thereby building a high
degree of customer loyalty.
SALES AND PROFITS
Starbucks’ net earnings in 2004 were $391.7 million, which is
a significant increase from the $181.2 million earnings three
years earlier. Furthermore, its revenues grew more than 12
times from $103.2 million in 1992 to $1.3 billion in 1998.
The increase in revenues and sales was a direct result of the
numerous new stores that were opened. During this period,
Starbucks stores grew 508 percent from 165 stores to over 1400.
By the third quarter of the year 2004, sales had increased 30
percent over those of the previous year to $5.34 billion. The
company’s stock saw a rise of over 2200 percent in the last
decade (see Exhibit 1).
COMMITMENT TO COFFEE
Starbucks is committed to selling only the finest whole-bean
coffees and coffee beverages. Currently the fifth largest pur-
chaser of coffee, Starbucks roasts more than 30 varieties of
the world’s finest Arabica coffee beans; therefore, the com-
pany goes to extreme lengths to buy the very finest Arabica
coffee beans available on the world market, regardless of
price. Arabica beans have a very refined flavor and contain
about 1 percent caffeine by weight. These beans account for
75 percent of the world production and are sought by specialty
roasters.
To ensure compliance with its rigorous standards, Star-
bucks is vertically integrated, controlling its coffee sourcing,
roasting, and distribution through its company-operated retail
stores. It purchases green coffee beans for its many blends and
varieties from coffee-producing regions throughout the world
and custom roasts them to its exacting standards. Currently,
there are three roasting plants in the United States. Roasts
that do not meet the company’s rigorous specifications, or
656 • Case 7 • Starbucks Coffee: Expansion in Asia

beans that remain in bins more than a week, are all donated million people who stop by Starbucks every week. The entire
to charity. Starbucks sells the fresh beans, along with rich- coffee market is estimated to be a $30 billion industry.
brewed coffees and Italian-style espresso beverages, primarily In keeping with its corporate mission, Starbucks is expand-
through its company-operated and licensed stores. ing its retail outlets at an incredible rate. Most recently, Star-
bucks has entered several new markets, including Toronto,
EXHIBIT 1 Rhode Island, North Carolina, and Tokyo.
NET REVENUES AND NET EARNINGS In addition to retail operations expansion, the company
(IN $MILLIONS) plans to selectively pursue other opportunities to leverage and
grow the Starbucks brand through the introduction of new
Net Revenues Net Earnings
products and the development of new distribution channels
Year (in $million) (in $million) (see Exhibit 2). Joint ventures with companies like Dreyer’s
1992 103.2 4.5 Grand Ice Cream, Inc., Pepsi-Cola, and Capitol Records have
enabled Starbucks to introduce new product lines into the mar-
1993 176.5 8.3
ket. In 1994, the company entered a joint-venture agreement
1994 284.9 10.2
with Pepsi-Cola to develop ready-to-drink coffee products.
1995 465.2 26.1 By the spring of 1996, the company launched a new bottled
1996 696.5 42.1 coffee drink called Frappuccino, a low-fat, creamy blend
1997 966.9 57.4 of Starbucks brewed coffee and milk. On October 31, 1995,
1998 1,300.0 68.4 a long-term joint venture with Dreyer’s Grand Ice Cream
1999 1,686.8 101.6 was announced. The joint venture yielded a premium line
2000 2,177.6 94.5 of coffee ice creams distributed to leading grocery stores
2001 2,648.9 181.2 nationwide. This line has become the number-one selling
2002 3,288.9 215.0 superpremium coffee-flavored ice cream in the nation. Finally,
2003 4,075.5 268.3 joint ventures with record companies such as Capitol Records
have enabled Starbucks to sell customized music CDs in its
2004 5,294.2 391.7
stores.
Starbucks is also trying to combine coffee with music to
COMMITMENT TO THE COMMUNITY give its customers a complete livingroom experience. After
Despite becoming extremely profitable, Starbucks has not lost getting into music production and sales, the company’s special
sight of being socially responsible. Starbucks has contributed ‘‘Hear Music’’ stores enable consumers to download and burn
to CARE, a nonprofit charity organization for the needy CDs from Starbuck’s library that includes 150,000 songs. Star-
in coffee-growing countries, since 1991. As North America’s bucks charges consumers $2 to use the music facility, $8.99 to
leading corporate sponsor, Starbucks has helped establish purchase the first seven songs, and 99 cents per song there-
health and literacy programs in Guatemala, Indonesia, Kenya, after. However, this novel move has not met the companies
and Ethiopia. This long-term charity program has helped expectations in the 45 test stores in the U.S. pushing forth
improve living conditions in the coffee-producing countries into music, the company launched a music channel on satellite
from which Starbucks buys. It is the company’s way of pro- radio in 2004.
viding assistance to those developing nations with which it Starbucks’ specialty sales and marketing team has contin-
does business. In addition, in 1996, Starbucks established a ued to develop new channels of distribution as the company is
Code of Conduct policy, which is the first step in a long-term growing. In 1991, the company began selling coffee in depart-
commitment to improving social conditions in the world’s ment stores and other places frequented by consumers, such as
coffee-growing nations. In 2001, the company joined an orga- Nordstrom and Barnes and Noble. Its plan to become a nation-
nization, TransFair, that works for the rights of farmers. The ally known brand is being pushed forward by a recent deal
efforts of the organization are oriented toward ensuring that with United Airlines, which gives Starbucks exclusive access
coffee farmers get a significant part of the amount ($1.26 a to 75 million domestic and international travelers. However,
pound) paid by coffee roasters for coffee beans. Also, in 2002, the company’s goal of expansion does not stop at airports. For
the company purchased 150,000 pounds of coffee beans from a two years, Starbucks has been the only coffee brand served in
fair-trade Consortium of Coffee Cooperatives of Guanacaste ITT Sheraton Corporate Hotels. In 1996, it also became the
and Montes de Oro in Costa Rica (COOCAFE). In 2005, coffee of choice in Westin Hotels & Resorts. More recently,
the company purchased 250,000 by 2005 and $1 million by it formed an alliance with U.S. Office Products to sell Star-
2006 to water projects in emerging countries. The company bucks coffee to offices throughout the United States. This
also announced that it plans to purchase 5 percent of its alliance is a tremendous opportunity for Starbucks to serve
total energy in North America in the form of renewable wind the workplace environment and overall strengthen its cus-
energy amid environmental concerns. tomers’ relationship with the Starbucks brand. In 2001, the
company began offering high-speed Internet access at some of
CURRENT SITUATION its stores to lure more customers. It also introduced the Star-
Coffee consumption in the United States has climbed to its bucks card, which now has over 4 million activations. Finally,
highest level in nearly a decade. In 1989, there were only Starbucks wants to grow its direct response and specialty sales
200 specialty coffee stores. Today, there are more than 9,000 operations. Starbucks’ direct response group launched a new
stores in 35 countries. The entire coffee market is estimated to America Online Caffe Starbucks store to sell its products via
be a $30 billion industry. There are estimated to be about 33 the Internet.
 Case 7 • Starbucks Coffee: Expansion in Asia • 657

EXHIBIT 2
STARBUCKS BUSINESS VENTURES
March 1995 Released Blue Note Blend coffee and CD jointly with Capitol Records.
September 1995 First Starbucks retail store opened within an existing and newly opened state-of-the-art Star Markets.
October 1995 Signed an agreement with SAZABY Inc., a Japanese retailer and restaurateur, to form a
joint-venture partnership to develop Starbucks retail stores in Japan. The joint venture was called
Starbucks Coffee Japan, Ltd. The first store opened in Tokyo in the summer of 1996 and marked
Starbucks’ first retail expansion outside of North America.
October 1995 A long-term joint venture with Dreyer’s Grand Ice Cream was formed to market a premium line of
cof fee ice creams. Nationwide distribution to leading grocery stores occurred in the spring of 1996.
November 1995 Formed a strategic alliance with United Airlines to become the exclusive coffee supplier on every
United flight.
January 1996 The North American Coffee Partnership was formed between Pepsi-Cola and Starbucks New
Venture Company, a wholly-owned subsidiary of Starbucks. The partnership announced its plan to
market a bottled version of Starbucks’ Frappuccino beverage.
February 1996 Formed an agreement with Aramark Corp. to put licensed operations at various locations marked by
Aramark. The first licensed location opened in the end of 1996.
September 1996 Introduced Double Black Stout, a new dark roasted malt beer with the aromatic and flavorful
addition of coffee with the Redhook Ale Brewery.
October 1996 Formed an agreement with U.S. Office Products Company, a nationwide office products supplier to
corporate, commercial, and industrial customers. The alliance will allow Starbucks to distribute its
fresh-roasted coffee and related products to the workplace through U.S. Office Products’ extensive
North American channels.
1998 Formed a joint venture with Intel Corporation. The venture will help push Starbucks into the market
of cybercafes.
1998 Formed an alliance with eight companies to enable the gift of over 320,000 new books for children
through the All Books for Children Holiday Book Buy.
1998 Acquired Seattle Coffee Company, UK’s leading specialty coffee company.
1998 Formed a joint venture with Mack Johnson’s Johnson Development Corporation to develop
Starbucks locations in underserved, inner-city urban neighborhoods.
1998 Formed long-term licensing agreement with Kraft Foods to accelerate growth of the Starbucks brand
into the grocery channel across the United States.
1999 Acquired Portland, Oregon’s Tazo Tea company and ‘‘Hear Music.’’ Formed alliance with
Conservation International for environmental friendly coffee-growing procedures.
2000 Orin Smith became President and CEO. Formed licensing pact with TransFair USA for sale of Fair
Trade Certified coffee.
2001 Introduced Starbucks card.
2004 Introduced in-store CD burning, formed licensing agreement to distribue Tazo Tea in U.S. grocery
stores.
2004 Formed strategic alliance with satellite radio, introduced new coffee beverage varieties.

Although profits for Starbucks have increased significantly
over the years, the company still has cause to be worried.
Overall sales are still growing quickly, but the rate of growth
is slowing at existing stores. Annual sales growth at stores has
slid from 19 percent in 1993 to 7 percent in 1996. The biggest
cause of sluggish sales growth is attributed to store canni-
balization. Starbucks has been known to open stores within
one block of each other in hopes of saturating the market. In
addition, growth has also been hurt by poor merchandising
efforts, which have left many products—like mugs and coffee
makers—on display for years.
INTERNATIONAL EXPANSION
With a stable business in North America, Starbucks plans to
expand abroad extensively. Starbucks’ international strategy
is to utilize two expansion strategies—licensing and joint-
venture partnerships. The success of expanding into foreign
markets is dependent on Starbucks’ ability to find the right
local partners to negotiate local regulations and other country-
specific issues.
Currently, Starbucks exists in an increasing number of
foreign countries (Exhibit 3) in Asia. The company felt that
Asia offered more potential than Europe. According to one
executive, ‘‘The region is full of emerging markets. Con-
sumers’ disposable income is increasing as their countries’
economies grow, and most of all, people are open to West-
ern lifestyles.’’ Finally, coffee consumption growth rates in
Southeast Asia are estimated to increase between 20 per-
cent to 30 percent a year. With this in mind, Starbucks has
plans to invest $10 million in developing its Asian opera-
tions and up to $20 million with its joint-venture partners
in Asia.
Starbucks does not yet have a roasting plant in Asia.
Instead, one shipment of coffee beans arrives in Asia every
other week to supply the company’s shops in Singapore and
Japan.
658 • Case 7 • Starbucks Coffee: Expansion in Asia

EXHIBIT 3
STARBUCKS INTERNATIONAL EXPANSION
Year of Entry/
Establishment Countries/Regions

1996 Hawaii, Japan, Singapore

1997 Philippines
1998 United Kingdom, Taiwan, Thailand, Malaysia, New Zealand
2000 United Arab Emirates, Shanghai, Hong Kong, Australia, Qatar, Bahrain
2001 Switzerland, Austria
2002 Oman, Germany, Spain, Mexico, Puerto Rico, South China, Macau, Shenzhen, Greece, Indonesia
2003 Turkey, Peru, Chile, Cyprus
2004 France
2005 Jordan

JAPAN Starbucks’ Japanese sales were 25 percent above the origi-

nally expected sales figures a few years back. However, as of
On October 25, 1995, Starbucks Coffee International signed
Fall 2002, same-store sales growth had fallen. From 1999 to
a joint-venture agreement with SAZABY Inc., a Japanese
2004, net profits stood at 6 million in Japan.
retailer and restauranteur, to develop Starbucks retail stores
On opening day in 1995 the Japanese crowded into Star-
in Japan. The joint-venture partnership is called Starbucks
bucks, and as many as 200 customers formed lines around the
Coffee Japan, Ltd. This alliance has proven to be a strong one
block to get a taste of Starbucks high-quality coffee. Starbucks
because it combines two major lifestyle companies that pro-
hopes to cultivate the same kind of coffee craze in Japan as the
vide the Japanese consumer a new and unique specialty coffee
one it has created in North America. However, profits from the
experience. Under this partnership, Starbucks opened its flag-
Japanese venture will not be visible for several years. Operat-
ship Tokyo store in the upscale Ginza shopping district in
ing costs in Japan, such as rent and labor, are extremely high,
1996, its first retail store expansion outside of North America
and Starbucks will also have to pay for coffee shipment from
and Europe.
its roasting facility in Kent to Japan. Retail space in downtown
Japan is an essential part of Starbucks’ international
Tokyo is also more than double that of Seattle’s rent.
expansion plan because the nation is the third largest coffee-
Starbucks plans eventually to open a roasting plant in Japan
consuming country in the world, behind the United States and
to help keep costs down. However, this plan is contingent on
Germany. Japan is also an ideal country because it has the
the success of the stores in Japan.
largest economy in the Pacific Rim.
Demand for coffee blends in Japan has doubled in the past SINGAPORE
five years, and specialty blends are the fastest growing segment
of the industry. One industry analyst said, ‘‘The Japanese have Economic Background
taken to coffee like a baby to milk.’’ Gourmet coffee accounts
According to the U.S. Department of State in 1990, Singapore,
for 2.5 percent of the 1.2 billion pounds of coffee bought by
otherwise known as the Lion State, has an annual growth rate
Japan each year. The average per capita consumption among
(1998—in real terms) of 11 percent. The country’s per capita
gourmet drinkers in 1997 was 1.5 cups a day, up from more
income is $8782, which is the third highest in Asia after Japan
than a half cup in 1990. The company picked Japan for its first
and Brunei. However, Singapore relies heavily on industry,
big overseas venture not only because it is the third-largest
with the industrial sector (including food and beverages) mak-
coffee-consuming country in the world, but also because the
ing up about 17 percent of Singapore’s real GDP. It imports
quality of its coffee products provides a major opportunity
about $44 billion in crude oil, machinery, manufactured goods,
for Starbucks’ specialty drinks. Japanese vending machines,
and foodstuff from the United States, European Community,
for instance, dispense $1 billion worth of cold, canned cof-
Malaysia, and Japan. In addition, Singapore is constantly look-
fee drinks. A similar bottled beverage jointly produced by
ing for new products and new markets to drive its export-led
Starbucks and Pepsi is in the process.
economy. It is attempting to become a complete business
Starbucks increased the number of its outlets to over 530
center, offering multinationals a manufacturing base, a devel-
by mid-2005, the highest number of stores in any country
oped financial infrastructure, and excellent communications
outside its home market, and it expects to open more stores
to service region and world markets.
in Japan. The stores offer the same menu as it does in its U.S.
However, the late 1990s was not a very good period for
stores, although portions are smaller. The names of items,
Singapore, for the country was affected to some extent by
such as ‘‘tall’’ and and ‘‘grande’’ are also the same as those
the Asian financial crisis. The economy grew at an annual
used in the United States. All of the stores will also feature the
rate of 8.7 percent from 1990 to 1996 but has since slowed
company’s trademark decor and logo. In addition, Japanese
down significantly. The main sector that was hurt by this slow
customers can purchase Starbucks coffee beans, packaged
growth was the manufacturing industry, which grew by less
food, and coffee-making equipment, as well as fresh pastries
than 3 percent, down from 10 percent in 1995. In addition,
and sandwiches.

the commerce sector grew by less than 4 percent, down from
9 percent in 1995. Analysts claim that weak economic growth,
global competition, and a very slow tourist season made Singa-
pore’s retail industry very sluggish. The restaurants and hotels
also recorded weak growth.
LIVING IN SINGAPORE
Singapore has one of the best living conditions in Asia. In 1999,
its per capita GNP was US$27,480. Furthermore, Singapore
is known for its diversity. There are 3.4 million Singapore-
ans: ethnic Chinese, Malays, and Indians make 77 percent,
14 percent, and 7 percent of the population, respectively. The
most practiced religions are Buddhism/Taoism (53.9 percent),
Islam (14.9 percent), Christianity (12.9 percent) and Hin-
duism (3.3 percent). The main languages are Malay, Chinese
(Mandarin), Tamil, and English. English is the language of
administration, whereas Malay is the national language.
With a moderately high cost of living, Singaporeans are
able to indulge in luxury goods. Much of Singapore’s enter-
tainment is influenced by Western culture. For instance, many
theaters show Broadway musicals such as Les Misérables
and feature pop concert artists like Michael Jackson. Televi-
sion programs are in English, Chinese, Malay, and Tamil. In
1992, pay TV channels such as CNN, Movievision, HBO, and
Chinese Variety were introduced.
Singaporeans are known to indulge themselves with food.
‘‘So discriminating have the Singaporeans become on the sub-
ject of quality and price that eating has become a national
obsession.’’ Singapore has an array of restaurants, coffee-
houses, fast-food outlets, and food centers that are easily
accessible and offer a variety of foods at affordable prices.
Most of these food places are not air-conditioned except
for those located in shopping complexes. However, eating in
an air-conditioned restaurant, regardless of income level, is
an affordable luxury. ‘‘The average lunch or high tea buffet
spread offering a wide variety of dishes is available at many
hotel coffee houses and restaurants, and it costs about $15
(Singaporean currency) or more per person. Most restaurants
and coffeehouses impose a 10 percent service charge, but
tipping is not encouraged.’’
SINGAPORE’S LOVE AFFAIR WITH COFFEE
According to Singaporean social commentator Francis Yim,
‘‘Coffeehouses are a sign that Singaporeans have achieved the
status of a developed nation and we are breaking new ground
in the area of becoming a cultured society.’’ In the past during
the construction of Singapore, Singaporeans did not have the
time to enjoy their cup of java. Regardless of their religion
and beliefs, Singaporeans went to coffeehouses in the evenings
for their meals and drank coffee in order to keep themselves
awake. Now coffee is viewed as a beverage instead of a drink.
People want to take the time to savor their coffee. It is not just
a drink but a personality altogether. The various flavors that
coffeehouses offer reflect the different moods as well as taste.
The first Starbucks coffee outlet in Singapore opened on
December 14, 1996, in Liat Towers, with the help of BonStar
Pte. Ltd., a subsidiary of Bonvests Holding Ltd., a Singaporean
company with food services and real estate interests. The store
in Liat Towers is located in Singapore’s main shopping district
on Orchard Road, which is a very trendy shopping center
including the French department store, Gallery Lafayette,
Case 7 • Starbucks Coffee: Expansion in Asia • 659
and Planet Hollywood. There are plans to open 10 to 12 more
Starbucks in Singapore within the next year. Currently, the
licensing agreement with Starbucks only covers Singapore,
but Bonvests hopes to expand the franchises into other Asian
markets. Starbucks’ venture into Singapore is its first expan-
sion into Southeast Asia. Bonvests Holdings anticipates that
the Starbucks retail stores will generate at least $40 million in
sales over the next five to six years.
Bonvests is an ideal partner for several reasons. Bonvests
has acquired expertise in running food businesses, such as the
local Burger King chain. They also know and understand the
local consumer market, government regulations, and the local
real estate market.
Starbucks chose Singapore for its entry in the Southeast
Asian market because of the highly ‘‘Westernized’’ ideas and
lifestyles it had adopted. Some have described Starbucks as
another American icon, like McDonald’s. Some even say that
Starbucks has created an American coffee cult. Slowly, but
surely, gourmet coffee bars have been penetrating into the
food scene in Singapore. It is estimated that Singaporeans
drink more than 10,000 gourmet cups a day. In addition,
the market in Singapore has tremendous growth potential.
According to Bruce Rolph, head of research at Saloman
Brothers Singapore Pte. Ltd., ‘‘People should increasingly
focus on Singapore not as a mature market with low earnings
and growth potential, but as a uniquely positioned beachhead
to get leverage over what’s happening in Asia.’’ Finally, the
Singaporean market still has no clear leader in the specialty
coffee industry. This means that Starbucks still has a good
chance to become one of the top contenders in this market.
Despite the opportunities that exist for Starbucks in Sin-
gapore, Starbucks still must overcome certain obstacles to
be successful. Competition is fierce, with 14 players and 38
stores between them (see Exhibit 4). With Starbucks entry
into the Asian market, bigger retail stores, like Suntec Dome
Holdings, are already gearing up for a coffee battle. However,
smaller companies like Burke’s Cafe and Spinelli are welcom-
ing Starbucks’ entry. Their strategy is to open an outlet right
next to Starbucks to attract the customers that overflow from
Starbucks.
One of Starbucks’ biggest competitors, Suntec Dome Hold-
ings, has already established itself in Singapore. It already has
good name recognition with Suntec Walk, Suntec City, Dome
Cafe, and so on. Suntec is distinctive from the other retail
coffee stores in that it is seen more as a restaurant than as a
coffee chain. It targets a broader market segment with a lower
budget range. They are also backed by major supporters with
the capital to counter Starbucks’ expansion strategy. In addi-
tion to Singapore, Suntec Dome Holdings has plans to expand
to other markets such as Malaysia, Indonesia, Thailand, Hong
Kong, and China. Spinelli, a smaller competitor, also plans
to expand into the region. With these expansion plans having
been completed by the year 2000, Spinelli is potentially a
major threat to Starbucks.
More well-known coffee spots to Singaporeans are Coffee
Connection and Coffee Club, which are also direct competitors
of Starbucks. The customers that go to Coffee Connection and
Coffee Club like the atmosphere and the service they receive
there. As reflected here, Singapore has seen a proliferation
of gourmet coffee outlets in the past few years; therefore, the
market is slowly becoming overcrowded.
660 • Case 7 • Starbucks Coffee: Expansion in Asia

EXHIBIT 4
COMPETITOR PROFILES
SPINELLI
Spinelli Coffee Company, long regarded by many as San Francisco’s best coffee retailer, has been licensed by Equinox for
expansion into Southeast Asia. Equinox is a joint venture between Golden Harvest, a Hong Kong film company, and
Singapore Technologies Industrial Corporation, a Singapore Conglomerate. Seven outlets were opened in Singapore’s
central business district by the fall of 1997, with up to 40 locations targeted for the region by the year 2000. In addition,
Spinelli is also in the process of setting up roasting factories to supply the Asian market. Spinelli brings to Asia years of
experience in sourcing, producing, and selling premium coffee drinks and whole bean coffee.

SUNTEC DOME HOLDINGS

Dome Café is a cafe modeled on European lines and was discovered by a Singaporean lawyer. It is best known for its
distinctive sidewalk and atrium cafes, where the food menu is longer than the coffee list. They serve light snacks and full
meals all day, from sandwiches made with foccacia (a flat, Italian bread) to exotic entrees like duck and pumpkin risotto.
Suntec Dome Holdings was formed in 1996 when Suntec Investment, an investment vehicle for a group of Hong Kong
tycoons, bought 51 percent stakes in the Dome Chain. Ronald Lee and Sebastian Ong, founders of Dome, imported the
European-style Dome concept from Australia. They are expecting to increase the number of outlets from 7 to 17 within
three years; an estimated $7 million is expected to be allocated for the expansion of outlets. Plans to build more roasting
plants to distribute Dome’s coffee in Asia are to follow, though roasting factories in Singapore and Australia exist
already. Their growth strategy is to expand into several Asian countries, with six outlets within two years in Malaysia and
plans for further expansion into Indonesia, Thailand, Hong Kong, and China are in the development stage.

COFFEE CLUB
Established coffee trading company Hiang Kie, now 60 years old, sniffed out the gourmet coffee trend and whipped up its
first outlet in Holland Village in 1991. There are 37 variations, from the humble Kopi Baba to the spicy, vintage tones of
Aged Kalossi Coffee. The best attraction is the Iced Mocha Vanilla—Macciato coffee and milk topped with vanilla ice
cream and a drizzle of chocolate syrup. In addition, they serve light meals of cakes, salads, sandwiches, and home-made
ice cream.

COFFEE CONNECTION
Coffee Connection is the latest, trendier incarnation of Suzuki Coffee House, started in the 1980s by Sarika Coffee to
showcase its Suzuki Coffee Powder. So far it is the mothership of coffee bars, with 69 different drinks ranging from cool
coffee jelly to Blue Mountain Chaser. The best attraction is the Cappuccino Italiano—espresso infused with hot milk,
topped with a frothy milk cap and dusted lightly with chocolate powder. They also serve ice cream, pasta, pizza, and
foccacia sandwiches.

BURKE’S COFFEE
Burke’s Coffee started from four Singaporean students who studied in Seattle, liked the espresso bars, and brought back
the concept. Burke’s Coffee is a Seattle-style cafe, bringing the lifestyle of the Pacific Northwest to Singapore. Burke has
made a name for itself as a friendly and inviting place in the midst of the hustle and bustle of downtown Singapore. The
store has established a loyal customer base of young professionals who visit the store frequently. Burke’s serves
sandwiches, soups, and desserts. There are seven basic coffee drinks, plus 12 Italian syrups that you can add on request.
The best attractions are the Mocha Freeze and Hazelnut Latte.

Starbucks will need to turn some heads and create the
brand equity it needs to stay in competition with its com-
petitors. However, it does have an advantage entering this
market. Starbucks packages a coffee-drinking experience that
the Singaporeans want, both trendy and American. As men-
tioned earlier, Singaporeans love American products, and
hopefully, that will translate into major dollars for Starbucks
in Singapore.
Starbucks faces a challenge in Singapore amid a prolonged
and still-depending crisis in the retail industry. Major retailers,
like Kmart and France’s Galeries Lafayette, have recently left
Singapore after much failure.
CHINA
It is probably a little easier to accelerate the sale of one’s
products in a market where demand already exists as com-
pared with a market that has a large number of potential
consumers and an emerging economy but low demand for the
product. This is the case with China, which is predominantly
tea-consuming and one of the smallest coffee markets in the
world.
Thus, when Starbucks inaugurated its first outlet in the
World Trade Center in Beijing, China, in January 1999, it
needed to proceed at a slower than accustomed pace. The
company now sells coffee through around 165 outlets that are
mostly concentrated in Beijing, Shanghai, and Hong Kong.
The company has collaborated with different partners for its
operations in China. In Shanghai and Hangzhou, Starbucks
has partnered with a unit of the President Group. The Pres-
ident Group is Starbucks’ partner in Taiwan, where it runs
around 80 coffee stores. In North China, the company has
partnered with H&Q Asia Pacific and Beijing Mei Da Coffee.
A replication of its stores concept worldwide, Starbucks
in China caters mainly to urban working people, and thus its

outlets are located in commercial areas. As for advertising
for the Chinese market, Starbucks depends less on domestic
advertising and more on promotion through coupons and vis-
its, which draw first-time consumers. Hence, although it faces
a challenging task, the company is determined to carve a niche
for itself in China’s beverage market. In 2005, the company
announced that in the long term, it expects the Chinese market
to be its second largest in the U.S.
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 8
GAP INC.
Since it started in 1969, Gap Inc. has been consistently grow-
ing and expanding. With more than 3000 stores in the United
States, Canada, the United Kingdom, France, and Japan, Gap
Inc. is currently the second largest-selling brand in the world
and is ranked second among all U.S. retailers in sales.
A HISTORY OF GAP INC.
Gap Inc. was established in August 1969 by Donald G. Fisher,
a real estate developer educated at the University of Califor-
nia–Berkeley. Fisher conceived the idea when he went to a
department store to exchange a pair of Levi’s and was unable
to because the jeans department was so disorganized. Backed
by a $63,000 family investment and a $112,000 bank loan
guaranteed by his father-in-law, Donald Fisher introduced the
first Gap store in San Francisco. His original idea was to focus
on the mid-teen market with three types of goods: records,
cassette tapes, and Levi’s jeans. Unlike the local department
stores, which stocked only a limited number of styles and sizes
of Levi’s jeans, the Gap store carried every size and style
available. Furthermore, they were neatly arranged and easy
to find. Donald Fisher and his wife had a discussion about the
‘‘generation gap’’ in 1969, and from that discussion came the
name Gap Inc., under which the company was incorporated in
California in July 1969. Gap Inc. was reincorporated in 1988
under the laws of Delaware.
GROWTH AND EXPANSION
Although the original targeted customers were primarily
young people, the convenience of a neatly organized jeans
store with Levi’s products attracted customers of all ages. In
less than one year, Gap’s business took off, and a second Gap
was opened in San Jose. In less than two years, there were six
Gap stores in California. By 1972, Gap Inc. had 25 stores in six
states. In 1973, Gap Inc. ventured into the East Coast market,
opening 12 stores in New York, New Jersey, and Pennsylvania.
In 1974, Gap expanded into Washington, Minnesota, Missouri,
Oklahoma, Maryland, Virginia, Georgia, Arizona, Texas, and
Illinois, with a total of 90 stores. In 1976, Gap Inc. went
public with its stocks, offering 1.2 million shares on the New
York and Pacific stock exchanges, selling at 75 cents a share.
This case was prepared by Masaaki Kotabe and updated by Sonia Ketkar
for class discussion rather than to illustrate either effective or ineffective
management of a situation described (2006).
Case 8 • Gap Inc. • 661
INDONESIA
In 2002, Starbucks launched its first coffee store in Jakarta,
Indonesia, after signing a licensing agreement with PT Sari
Coffee Indonesia. It is housed on the ground floor of the Plaza
Indonesia, an upscale fashion shopping center, and boasts of
the familiar Starbucks atmosphere of coffee, conversation,
and more. The company plans to expand its operations in
Indonesia based on the response it gets to its first store.
In 1979, Gap Inc. opened a modern distribution facility in
Denver, Colorado. By 1981, Gap Inc. had opened 500 stores
nationwide. In 1983, Gap Inc. purchased Banana Republic, a
travel clothing company that sold mainly through catalogs. By
1985, there were 613 Gap stores and 35 Banana Republics.
The first GapKids store was introduced in 1987; then in 1988,
the Old Navy Clothing Company was first introduced. In the
same year, Gap opened two factory outlets selling merchan-
dise at discount prices. In 1990, GapKids formed a separate
department for baby clothing called BabyGap. In 1992, Gap
stores also formed a separate department called Gap Shoes.
The year 1993 was marked by the opening of Gap warehouse
or outlet stores as well as an entry into the French market. Old
Navy was started in 1994, and the following years witnessed
the introduction of online Gap Maternity and the launch of
the e-businesses of Gap, Banana Republic, and Old Navy.
As of 2005, the company operated:
• 3,010 stores in the United States, Canada, United Kingdom,
and Japan.
• 462 Banana Republic stores, including 18 in Canada.
• 907 Old Navy stores.
• the total number of stores in:
United Kingdom 134
Canada 173
France 33
Japan 84
SELLING PRIVATE STORE BRAND PRODUCT
Within three months of opening the Gap, Fisher realized that
the real business was in selling Levi’s jeans, so he dropped the
records and cassette tapes from his inventory. Until the end of
1973, Gap advertised and carried only Levi’s brand products.
In 1974, Gap introduced its first private-label clothing into
the merchandising mix. When price maintenance crumbled
because of a Federal Trade Commission directive in 1976,
Levi’s products began to sell at discount, and Fisher was con-
vinced that Gap’s competitive advantage could not rely solely
on the low prices of Levi’s products. Since then, he has focused
on reducing Gap’s reliance on sales of Levi’s products. As a
result, Levi’s products began to decrease as a percentage of
Gap’s total sales. By 1987, Levi’s made up less than 50 per-
cent of Gap’s total sales. By 1985, Levi’s sales dropped to 21
662 • Case 8 • Gap Inc.
percent of Gap’s total sales, then 14 percent in 1987. Finally, in
1990, Gap dropped Levi’s altogether and started selling only
private-labeled products.
GAP INC. OPERATING COMPONENTS
Gap Inc. is a specialty retailer that operates stores selling
casual apparel, shoes, and other accessories for men, women,
and children. It includes the following registered trade names:
Gap, GapKids, BabyGap, Gap Shoes, Gap Maternity, Banana
Republic, and Old Navy Clothing Company. In April 2005,
Gap Inc. announced the launch of its newest brand, Forth
& Towne apparel and accessories for women over 35. The
company planned to open four test stores in Chicago and New
York in Fall 2005. The baby boomer age and the spreading
ability of this age group has created an opportunity for the
company.
The company has continued to focus on developing and
growing its brands, and it believes that its brands are among
its most important assets. The company is taking action to
maintain and strengthen brand loyalty, including significantly
increasing its investment in advertising and marketing.
Besides expanding the number of print ads placed in major
metropolitan newspapers and their Sunday magazines, major
news weeklies and lifestyle and fashion magazines, the com-
pany’s ads appear in various outdoor venues, such as mass
transit posters, exterior bus panels, bus shelters, and gigantic
billboards spanning entire buildings. The company continues
to run TV ads for all of its brands and radio ads for Old
Navy.
The company continues to add flagship stores and increase
television advertising to complement its in-store customer
service focus. The company also continues to invest in store
expansion as well as development of new distribution channels
to address changing market requirements. Its new channels
of distribution include Gap Online, Old Navy Online, Gap
Maternity Online, and a catalog for Banana Republic. The
company has a limited operating history in these new channels
of distribution and is faced with competition from established
retailers in these new lines.
The retail apparel business fluctuates according to changes
in customer preferences dictated in part by fashion and season.
These fluctuations especially affect the inventory owned by
apparel retailers, since merchandise usually must be ordered
well in advance of the season and sometimes before fashion
trends are evidenced by customer purchases. Gap is also vul-
nerable to changing fashion trends. In addition, the cyclical
nature of the retail business requires the company to carry a
significant amount of inventory, especially prior to peak sell-
ing seasons when the company and other retailers generally
build up their inventory levels. Gap must enter into contracts
for the purchase and manufacture of apparel well in advance
of the applicable selling season. As a result, the company is
vulnerable to demand and pricing shifts and to suboptimal
selection and timing of merchandise purchases.
RETAIL DIVISIONS
Gap operates under different divisions: Gap, Banana Repub-
lic, GapKids, BabyGap, Old Navy, and International Division,
among others. The first seven operate domestically, and the
last one operates all of the stores from the first seven divi-
sions that open overseas. The company continues to expand
internationally each year. It is faced with competition in
European and Japanese markets from established regional
and national chains. If international expansion is not success-
ful, the company’s results of operations could be adversely
affected. The company’s ability to grow successfully in the
continental European markets will depend in part on deter-
mining a sustainable profit formula to build brand loyalty
and gain market share in the especially challenging retail
environments of France.
Gap Division. This division has by far the most stores—more
than all of the other divisions combined—with 1,291 stores
operating in the United States in 2005. The Gap Shoes sub-
division also operates under this division. All stores under
the Gap division are called The Gap. The Gap stores are
classified as clothing retail stores for men and women, with
Standard Industrial Code 5651. In the United States, there
are 145 domestic competitors for The Gap; and in 1998 The
Gap ranked third in sales. In the beginning, products under
this division consisted of an assortment of unisex basics; but
recently they have evolved to become more gender specific. In
2004–2005, the company engaged well-know celebrities like
Sarah Jessica Parker and musician Joss Stone to promote the
Gap brand.
Banana Republic Division. When purchased in February
1983, Banana Republic was already famous for its travel and
safari wear, but only two Banana Republic stores existed.
After the purchase was completed, the parent company cre-
ated a new division to operate all Banana Republic stores. Gap
Inc. also invested capital to create a product development and
production team for Banana Republic, allowing it to introduce
its own new private-label fashions. In addition, there was rapid
expansion into other parts of the country. Products under the
Banana Republic division are more upscale, more tailored, and
come in more refined fabrics than those in The Gap stores.
Leather goods and jewelry goods have been introduced into
the merchandise mix. Internationally, Banana Republic stores
are run only in Canada but in 2005, the company announced
that it would open two stores in Japan in the shopping districts
of Ginza and Roppongi. The company also offers these prod-
ucts online on www.bananarepublic.com. Banana Republic
has sales of over $2 billion in the North America. Presently,
the company is trying to move toward being a fashion house
by showcasing its designs in fashion shows.
GapKids Division. After this division was formed in 1986,
it became the fastest growing division of Gap Inc. All stores
under this division are called GapKids stores. Products in this
division are essentially miniature versions of The Gap prod-
ucts, but with more focus on color variations. These products
have also switched from unisex to more gender specific. The
formation of the BabyGap subdivision under GapKids is
another reason for the rapid growth of this division.
Old Navy Clothing Company Division. This division oper-
ates all Old Navy Stores and Gap Warehouses. There are
now 907 Old Navy stores operating under this division since
the first introduction in 1994. There is also a Gap Warehouse
operating under this division. The formation of the Old Navy
division came at a time when sales were down, and Gap Inc.

needed new ways to attract customers. The strategy was to
sell merchandise similar to Gap stores but at lower costs.
This division is expected to surpass the GapKids division and
become the fastest growing division of Gap Inc. Internation-
ally, Old Navy stores, too, exist only in Canada. The company
also offers these products online on www.oldnavy.com. The
company plans to open 200 new stores by 2007 and add new
lines such as plus sizes, maternity, and personal care.
International Division. All stores located in foreign coun-
tries are under the control of the International Division. This
division includes Gap, GapKids, Banana Republic, and Old
Navy stores. The first overseas store was established in 1987
in London, thus gaining entry into the British apparel market.
In 1988 the first store in Canada was established, and in 1993
the first store in France was opened. As of 1994, the Inter-
national Division operated 40 Gap and GapKids in England,
59 in Canada, and 3 in France. International Division also
operates Banana Republic in Canada and Australia. Interna-
tional Division shows strong growth potential and continues
to expand existing markets in Europe and to gain major entry
into new market including Japan.
PRODUCTS AND CUSTOMER BASE
The Gap division sells mainly men’s and women’s casual
and active wear. Clothing items, including jeans, sweat suits,
sweatshirts, denim wear, and polo-style pocket T-shirts are
marketed. The Gap division has also expanded its market to
include handbags, shoes, and a higher fashion line of evening
wear. In addition, during the 1990s, the Gap division entered
the bodycare products and cosmetics market, introducing
soaps, body lotions, shower gels, shampoos, conditioners, aro-
matic candles, and other related items. In addition to selling
travel and safari wear, the Banana Republic division sells
men’s and women’s casual wear, made of finer fabrics and
priced higher than can be found in Gap stores. Together, the
Gap stores and the Banana Republic divisions target mainly
customers 20 years or older. GapKids, which sells miniaturized
versions of Gap store products, originally aimed at children
aged 2 to 12, but with the introduction of BabyGap, it has
been able to add even younger customers to its customer base.
The most recently introduced Gap Maternity sells maternity
wear only through its Web site. The Old Navy Division, sell-
ing cheaper products, targets lower-income shoppers. The
International Division targets foreign customers in similar age
groups mentioned earlier.
SOURCING
Gap purchases merchandise from some 700 sources located
both in the United States and in around 50 countries overseas.
This procurement strategy is designed to reduce each sup-
plier’s importance, so that no single supplier can affect Gap’s
overall operations significantly. All suppliers account for no
more than 5 percent of the purchase. The suppliers manu-
facture the Gap’s private-label merchandise according to the
company’s specifications. Gap purchases are comprised of 40
percent domestic-made merchandise and 60 percent foreign-
made merchandise. Of the foreign sources, approximately 23
percent are from Hong Kong, and the remaining purchases
are spread across 42 other countries. Hong Kong, Taiwan,
South Korea, Singapore, and China constitute over 50 percent
Case 8 • Gap Inc. • 663
of Gap’s foreign merchandise sources. Sudden political insta-
bility in any of these countries could quickly have an adverse
effect on Gap’s sourcing operations, as would any imposition
of import restrictions such as tariffs and quotas by the U.S.
government on products made in these countries.
Hong Kong is by far the most important foreign source
of Gap’s merchandise. Hong Kong has a total population of
6.019 million, of which 17.8 percent are engaged in manufac-
turing and 33.6 percent are in either retail trade or wholesale.
Until recently, Hong Kong had an unemployment rate of
only 2.2 percent, and the Hong Kong government had to
import labor from abroad to counter a shortage in labor
supply. Despite this labor shortage, the well-educated labor
force in Hong Kong is relatively cheap to employ, and with
the increased pressure of manufacturing companies moving
across the border into China, even cheaper labor may result.
U.S. retailers, including Gap Inc., have long been the target
of criticism for selling goods imported from Hong Kong and
other low-wage countries such as Taiwan and South Korea. In
addition to its low-wage rate, Hong Kong is a favored apparel
source for many retailers because of the flexible manufac-
turing and quick response strategies introduced by the Hong
Kong Productivity Council and adapted by many of Hong
Kong’s apparel producers. Both of these strategies reduce
inventory costs for the retailers. Furthermore, the apparel
industry in Hong Kong is now adapting to many new tech-
nologies and production methodologies, all aimed at reducing
apparel production costs.
Like other Western firms that employ labor at sweat shops
in emerging countries, Gap has often been accused of profiting
from such practices. Therefore, Gap now has over 85 sup-
plier compliance officers who screen prospective and present
suppliers for acceptable labor practices.
ADVERTISING
Gap Inc. advertises mainly through major newspaper publi-
cations, but it also advertises in fashion magazines and on
mass transit posters, billboards, and exterior bus panels. All
advertisements stress the central theme of American design,
quality, and moderate pricing, although they are produced
separately in each country to suit local tastes.
DISTRIBUTION
All merchandise is shipped to distribution centers for dis-
tribution. These centers are located in California, Kentucky,
Maryland, Canada, and the United Kingdom.
MARKETING
The company has a separate marketing team for each brand.
The teams are headquartered in San Francisco’s Bay area
in California. These headquarters are also responsible for
advertising.
PERFORMANCE
Although Gap Inc. saw increasing earnings until 1999, the next
few years witnessed a fall in earnings (see Exhibit 1). Indus-
try experts cited a variety of reasons for dipping revenues,
such as launching too many stores to having no differentiation
between its brands. Although the company presently has ade-
quate cash flow to settle its debts in the immediate future, it
will have to find a way to get back on track to profitability to
664 • Case 8 • Gap Inc.

sustain itself in an economy characterized by fierce competi-
tion. In 2002, Gap’s debt was downgraded by analysts to junk
bond status. The company fared better in the next couple of
years. However, profits fell again in the first quarter of 2005,
so the company is now looking into bringing about more styles
and designs in women’s clothing to bring it back on track to
profitability.
their cost of doing business in Canada by making it cheaper
to import their products from the United States. Canada even
assists U.S. companies planning to enter the Canadian market
through the United States and FCS Export Assistance Ser-
vice. Along with fewer government restrictions, Gap Inc. did
not encounter the traditional barriers of entry such as local
content requirements, political turmoil, and import quotas.

EXHIBIT 1 Market Expansion. In 1992, Gap Inc. made a big expansion

NET SALES AND EARNINGS COMPARISON move further into the Canadian apparel market. In a joint
venture with John Forsyth Company Inc., Gap Inc. began to
Net Sales Net Earnings
compete on the same level as native Canadian apparel compa-
Year (in US$ Billion) (in US$ Million) nies such as Hudson Bay Company. With the impending North
1993 3.2 258.4 American Free Trade Agreement, Canada’s borders were now
completely open to outside competition. This development
1994 3.7 320.2
paved the way for even more store openings for Gap Inc.
1995 4.4 354.0
Now, Gap Inc. not only has to compete with Canadian
1996 5.2 452.9 apparel companies like Hudson Bay Company for market
1997 6.5 533.9 share, but also with new U.S. companies in Canada such as
1998 9.1 824.5 The Limited. This increased competition has made Gap Inc.
1999 11.6 1127.1 look at further Canadian expansion from a different perspec-
2000 13.6 877.5 tive. According to Gap Inc.’s Ken Rapp, ‘‘The holdup is no
2001 13.8 −7.8 longer a free trade issue, but a dearth of good retail space in
2002 14.4 477.4 Canada where there are fewer shopping malls per capita and
2003 15.8 1030.0 lower vacancy rates.’’
2004 16.3 1150.0 With ever-increasing success, Gap Inc.’s Canadian stores
began to branch out with Canadian versions of the U.S. Gap-
Kids and BabyGap in the early 1990s. This expansion was
GAP’S FOREIGN MARKETS
made possible in part by Canada’s recovering economy and
Gap’s foreign markets include Canada, Britain, and France. notable growth in the apparel industry. Turtleneck jerseys, a
Following is a detailed analysis of these markets. Gap staple, rose in sales 122 percent. Men’s outerwear rose 17
percent after a three-year decline.
CANADIAN MARKET
As store openings increased across the United States dur- Growth Projections. Riding on the success of Gap and Gap-
ing the 1980s, Gap Inc. began to realize the potential for Kids stores, Gap Inc. believed its Banana Republic division
expanding into the Canadian market. would not have a difficult time establishing stores in Canada.
Thus, Banana Republic, a more upscale, higher-priced ver-
General Economy. During the mid-1980s, prior to Gap Inc.’s sion of The Gap, opened stores in Eaton Center in Toronto
Canadian involvement, Canada enjoyed a stable and slowly and West Edmonton Mall in Alberta. Gap Inc. seeks to steal
growing economy. This brief boom was followed by a recession some market share from existing Canadian chain stores such
in the late 1980s. While other Canadian companies suffered, as Roots, River Road, and Eddie Bauer by installing Banana
Gap Inc. sought to gain first-mover advantages by riding a pos- Republic stores.
sible rebound in the economy and tried to become a dominant
player in the Canadian apparel industry. The Canadian gov- Market Characteristics. According to the International
ernment imposes few restrictions on foreign direct investment. Trade Administration’s Canadian Market Overview, the new
This was a major decision factor in Gap Inc.’s move to set up trend in the Canadian apparel market is to economize by sav-
stores in Canada with the opening of eight stores in Vancouver ing money on clothing. This is because of increases in housing
in March 1989. The first of these was in Vancouver’s Pacific costs and taxes. Female consumers are becoming more time-
Center. pressured, and as a result, they are spending half as much
time per month shopping as they did 10 years ago. In general,
Government Regulations. Since it is a good environment for adult consumers are becoming more knowledgeable about
apparel market penetration, Canada subscribes to the Gen- the clothing they buy and are more careful in evaluating their
eral Agreement on Tariffs and Trade. This greatly influenced purchases in terms of value.
Gap’s later decisions to expand into other countries as well.
UNITED KINGDOM MARKET
Even though Gap Inc. conducts its sourcing mostly outside
of the United States, it ships those goods back through the According to UK trade journals, American apparel is making
United States, so that they have to be imported into countries a strong showing in the British market and will continue to
like Canada. In addition, Canada’s goal of totally eliminating do so in the near future. Approximately 60 percent of men’s
tariffs on goods of U.S. origin by 2000 provided Gap Inc. with apparel and 35 percent of women’s apparel are sold through
an advantage on entering the Canadian apparel market. This retail stores. However, Gap stores in the U.K. have not been
trend has enabled American companies like Gap Inc. to lower able to satisfy the market, and in mid-2003, the company

decided to close 13 of its stores in the region. In 2004, losses
at UK stores were at all time high.
Market Size. According to the 2001 International Market
Report, the British market for men’s apparel was about $3.34
billion, and the women’s apparel market about $4.59 billion.
Both are in decline because of recession.
Market Health. The UK market for apparels is currently in a
recession. British retailers are hoping for ‘‘business as usual’’
once again in the not too distant future, but according to
market analysts, recovery is still a long way off. There are
occasional mini-surges in consumer spending, and retailers
have devised some strategies to capitalize on these surges.
One strategy is to lower price while stressing quality. Another
is to adopt the ‘‘one-stop-shopping’’ concept, that is, pairing
men’s and women’s merchandise together in one store so both
can be bought simultaneously. This strategy was in response to
an observation that consumers now have a tendency to come
in couples. Some retailers even place children’s apparel items
along with men’s and women’s apparel items, thus creating a
true ‘‘one-stop-shop.’’
Market Trends. British consumers are highly receptive to
U.S.-designed and -manufactured apparel items. Studies show
that the average British consumer thinks of American design-
ers as firm believers in making practical clothes for real people,
as compared to European designers who make fashion show-
style clothing that is unwearable. Outerwear sold by such
retailers as Gap Inc. and Timberland is very popular. Men’s
and women’s apparel trends differ in that menswear tends to
be more basic; the changes are usually in color and fabric,
not style. Men are moving toward plainer pieces and away
from heavily logoed styles. Women’s purchases focus more on
fashion designer labels.
Customer Base. The 15- to 25-year-old age group tends to
make purchases in boutiques. Older consumers shop in stores
that are well known for quality, durability, and good value.
Most retailers now are focusing on customers who are over
25 years old. This is because of increasing youth unemploy-
ment and an aging population of baby boomers. A significant
percentage of the customer base is made up of large-sized
customers, particularly women.
Competition. American-made apparel faces competition
from European designers, Asian-made apparel, and from
each other. European designers from the European Union
can ship their goods to the United Kingdom duty-free, and
Asian-made items are usually produced by cheap labor.
Government Regulations and Market Access. There are few
trade barriers for apparel. No special forms of documentation
are required for apparel items going to the United Kingdom.
No special standards are set. No import licenses are necessary.
Textile raw materials enter the United Kingdom with up to
15 percent duty, while finished apparel items are charged with
up to 14 percent duty and value-added tax of 17.5 percent.
No duties have to be paid for goods imported temporarily to
the United Kingdom or located in free ports (UK free-trade
zones).
Case 8 • Gap Inc. • 665
FRENCH MARKET
France is Gap’s new foreign market, and 33 Gap stores operate
in France. The following analysis of the French apparel market
includes size of market, characteristics of growth, growth pro-
jection, industry structure, competitors and substitutes, and
government regulations.
Market Size. According to the U.S. Department of Com-
merce World Apparel Market Research Report published
recently, France was the sixth largest market for apparel, with
demand of over $12 billion. It was also the sixth largest market
for apparel imports from the United States, with total demand
of $200 million.
Market Characteristics and Current Growth. The French
apparel market can be characterized as a mature, sophisti-
cated, slow-growth market rather than an emerging market. It
is experiencing 4 percent average annual growth and 2 percent
annual growth in its market for U.S. imports. The United
States does not have a large share of the French market at the
moment. However, the French are becoming more receptive
to U.S. fashion, especially U.S. sportswear. French women
are just beginning to buy American-made apparel, and the
natural ‘‘American look,’’ especially Western-wear clothing,
is becoming popular in France. The 15- to 25-year-old age
group is very fashion conscious and strongly influenced by
American styles, especially jeans and college or football team
logo apparel.
Growth Projections. The industry has suffered from the
worldwide economic slowdown since 1991, but some sales
improvements have occurred since 1994. Apparel sales are
expected to grow at a rate of 2 percent. In spite of the low
market share of U.S. firms, France is very promising for
Gap Inc. The French have a high level of receptiveness to
U.S. goods, and the market for U.S. imports is expected to
continue to grow at 2 to 3 percent annually. Unfortunately,
local and third-party competition is high, but market barri-
ers in this area are negligible and do not pose a problem.
According to the U.S. Department of Commerce, Interna-
tional Trade Administration, currently the two most promising
subsectors in apparel for U.S. companies are sportswear and
jeans.
Business Environment. The French commercial environ-
ment is very dynamic and sophisticated, and quickly reflects
consumer trends. There is a strong market for high-quality
consumer goods. Independent specialty stores are the main
means of distribution in affluent cities.
Business Attitude Toward the United States and Exit/Entry
Barriers. In general, the attitude toward American compa-
nies is favorable, and the French are quite receptive to U.S.
goods and services. However, strong interest groups are pow-
erful influences on business judgment and government action
or inaction. These interest groups have been known to stage
noisy demonstrations, but they usually are a problem only for
companies that pose a major threat to French suppliers.
There are no major entry or exit barriers to doing business
in France for most companies. Tariffs and duties on American
products are discussed later.
666 • Case 8 • Gap Inc.
Competitors and Substitutes. Local and third-party competi-
tion is rampant in the French market. It is particularly heavy
in the consumer area where buyers are just beginning to look
for ‘‘value’’ in their product choices, and most product lines
that are available are mature. In this mature and sophisticated
market, consumers are well served by suppliers around the
world. Therefore, major business breakthroughs are unlikely,
but opportunities can be created in niche markets.
There is a natural tendency now for the French to buy
apparel from within the European Union because of the
increasingly free flow of goods since the integration of Europe.
Italy is and always has been a significant high-quality clothing
competitor in France. However, Gap’s main competitors are
North African and Southeast Asian companies, which have
a strong presence in France because of their low production
costs. At the moment, Asian countries have 31.7 percent of
the French market for women’s clothing, and this number is
expected to remain constant.
There has also been an increase in imports from Morocco,
Tunisia, Portugal, and, recently, Eastern Europe. Again, com-
panies from these countries enjoy low production costs and
close proximity to the French market. Morocco and Tunisia
are actually the main suppliers of menswear imports to France,
but the U.S. share of the menswear market has been increasing
rapidly.
As far as substitutes, there has been a massive growth of
supermarkets and hypermarkets (huge shopping stores with a
wide variety of products) in France, not just in food but also
in apparel. These stores could pose a threat to specialty stores
such as The Gap if people begin doing all of their shopping at
hypermarkets and stop going to the specialty stores.
Government Regulations and Controls. France has had a
tradition of highly centralized administrative and governmen-
tal control of its essentially market economy. However, the
apparel industry has little restrictions other than tariffs and
duties on imported products.
As part of the European Union, the TARIC system applies
duties to all imports from non-EU countries. This gives Euro-
pean companies a slight cost advantage over U.S. companies.
However, this advantage can be negated if production costs
for U.S. companies can be lowered. Duties on manufactured
goods from the United States are moderate, ranging from
5 to 17 percent; they are calculated as a percentage of the
value of the imported goods. Under the Lome Convention,
varying preferential tariff treatment is given to imports from
developing countries in Africa, the Caribbean, and the Pacific,
which gives companies an incentive to manufacture in these
countries.
AUSTRALIAN MARKET
Following the lead of successful U.S. retailer Toys ‘‘R’’ Us,
Gap Inc. has been negotiating possible sites for another
international outlet. Store location, product positioning, and
marketing and advertising decisions depend heavily on how
Gap executives assess the following conditions.
Economic Health. Consumption expenditures continue to
increase in the face of high unemployment, which rose by
2 percent in 1992 and by 7 percent in 1993. A reverse in this
trend in 1994 and 1995 has since been the key to a robust
recovery. The average annual growth rate for the apparel
market during this period is expected to be between 3 and
5 percent.
The downward push against inflation was one of the few
positive effects of the recent recession. Lower inflation num-
bers are a positive sign to potential investors, many of whom
have been discouraged by the sliding Australian dollar. A
strong local currency is helpful for specialty retailers like the
Gap on two levels. First, its products will become relatively
more price competitive. Second, Gap would benefit from a
strong Australian dollar through translation gains, as profits
are repatriated.
Others are wary that the removal of quotas and tariffs will
foster a fiscally unhealthy demand for imports. If past per-
formance is any indication, economic expansion would most
likely lead to a rise in the current account deficit. Officials cite
that if the Australian president’s goal of 4 to 5 percent GDP
growth is realized, the current account deficit will increase
from 3.75 to 4.25 percent of GDP during the same period.
Market Barriers and Government Regulations. In the recent
past, currency exchange rate levels and hefty import duties
made it difficult to sell U.S. apparel products in Australia.
Thankfully, import duties are on the decline, and the Aus-
tralian government promised that this figure would continue
to fall, via the TCF tariff reduction program, by 3 percent
annually until the year 2000. The tariff on textiles and apparel
was then expected to level off at 25 percent. Add to this
the abolition of import quotas in February 1993, and for-
eign apparel retailers and their products become increasingly
attractive in the face of domestic competition. This despite the
recent ‘‘Buy Australian’’ campaign, which Australian officials
insist has successfully increased consumers’ preferences for
locally made products.
Gap Inc. executives must also consider the additional costs
associated with the newest clothing standards to be adopted
by Standards Australia, a national regulatory committee. The
new standard rates clothing according to the protection it
offers from the sun. If adopted, Gap must carefully consider
which products should be introduced in Australia and possibly
reconsider its own internal manufacturing standards.
Competition. Competitors vying for the US$1.5 billion in
apparel revenues include traditional department stores, dis-
count retailers, mail-order companies, home shopping clubs,
and a growing contingent of specialty shops, including Gap.
Industry sources estimate that 15 percent of the market is
captured by traditional retailers and 85 percent of the market
is sold through other means. Experts also say that, of the
expected 4 percent growth in the apparel market, an increas-
ing proportion is expected to be captured by competitively
priced imports. Competitors in Australia’s apparel market
break down as follows:
Department Stores. Department store leaders like Coles
Myer, David Jones, and Georges sell to the middle of the mar-
ket. These stores tend to sell higher-quality apparel goods,
with various departments devoted to discount and specialty
apparel. Coles Myer, for example, has a Myer’s Bargain Base-
ment department, and its rival Georges offers a floor devoted
exclusively to international apparel. Gap will take business
mainly from David Jones and Coles Myer.

Chain Stores and Boutiques. These stores generally sell
according to the selective tastes of their target markets. Gap
stores are somewhat different from these retailers in that they
would sell Gap brand items exclusively. Sportsgirl, catering to
female teenagers, and Portmans are the largest in this segment
and would compete directly with Gap.
Mail-Order Companies/Home Shopping Clubs. Through
its subsidiary Myer’s Direct, Coles Myer has broadened its
attack on consumers on two fronts: mail-order catalogues and
a new home shopping program. The initial response to the
home shopping program was not very enthusiastic; however,
its mail-order business, the largest in the country, has been
more successful, averaging 50 to 60 percent growth since its
inception in 1989.
Positioning. Gap Inc. should continue to take advantage of
its niche appeal as a U.S./California-based apparel company.
Although U.S. companies, in general, face heavy competition
in Australia, single-brand stand-alone stores like the Gap will
always find opportunities in niche markets. Gap should avoid
competing on the basis of price with imports from China and
Hong Kong. Gap’s greatest initial success will come from
providing one of Australia’s populous cities, such as Sydney
or Melbourne, fashionable, high-quality ‘‘American’’ apparel
products.
GERMAN MARKET
Gap operated 20 stores in Germany until the beginning of 2004
when it sold all of its unprofitable German stores to Swedish
apparel retailer H&M. Gap executives faced the following
challenges and opportunities that are unique to the German
apparel market.
Market and Economic Health. In 1998, Germany was ranked
at the top of the list of apparel importers at over $30 billion.
A closer look shows that the most promising subsectors were
sports, leisure and casual wear (US$7 billion), and jeans wear
(US$4 billion). Average annual growth for Germany’s apparel
industry through 2000 is estimated to be around 3 percent.
The German clothing industry fared well under the prevail-
ing conditions of the late 1980s and early 1990s, which were
a result of the ongoing reunification process. The opening of
East Germany, with a population of 16 million, offers poten-
tially large profits and a number of challenges for apparel
managers seeking new markets. For the most part, apparel
retailers are choosing to enter this market through joint ven-
tures and partnerships, but others, like Levi Strauss, have
chosen to establish their own branches. Still, progress in this
region is painfully slow as the transition from a command
economy to a market economy progresses.
Consumer Attitudes. Consumer spending is an integral part
of economic growth in Germany and for Europe as a whole.
Lately, however, German consumers have been unwilling to
participate, and recovery in the region has stalled. Several
factors have contributed to this cautious consumer attitude:
rising unemployment, which was already 10 percent, higher
rents, which have increased by 6 percent in the West and by as
much as 58 percent in the East, and high tax rates—currently
34.4 percent for the average worker. Even Germans from the
East, who were hungry for consumer goods from the West,
Case 8 • Gap Inc. • 667
are becoming finicky shoppers. The bargain shopping attitude
that is prevalent in the United States has found its way to East
Germany. ‘‘They don’t buy so many trendy articles—it’s back
to basics like T-shirts, jeans, blazers, and sweaters.’’
Competition. Because of these recent changes in consumer
attitudes, low-cost apparel imports now dominate the German
market. Basic items from Eastern Europe, Turkey, and Asia
can be found for one-tenth of the price of comparable U.S.
offerings. This is not to say that consumers in Germany are
not willing to pay higher prices for U.S. goods. Items must
not only be of good quality, but must also carry a well-known
American trademark.
Leading competitors include Hugo Boss, a men’s-wear
manufacturer and retailer that is currently the most profitable
in Germany. Boss’s success is mostly a result of repositioning
its product lines. It has recently included a lower-end product
line under a different label, in addition to its traditional mid-
priced and premium-priced offerings. Gap will be in direct
competition with Hugo Boss for casual wear revenues. Adler,
a discount fashion chain, has 60 stores in Germany, 10 of
which were recently opened in East Germany. Gap should
avoid competing head to head with Adler on a price per unit
basis.
Positioning. Germans have shown a willingness to pay a pre-
mium for highly recognizable American goods and have done
so, paying between $80 and $100 for a pair of Levi’s jeans.
Strong, pervasive television and print advertising is the key to
creating this image awareness.
JAPANESE MARKET
Gap currently operates 84 stores in Japan. With a total popu-
lation of 125 million people, Japan is an excellent market for
Gap’s products. The following is an overview of this market.
Market Size. The U.S. Department of Commerce World
Apparel Market Research Report shows Japan as being the
largest total market for apparel with total demand of $70 bil-
lion. It is the second largest market for apparel imports from
the United States with a demand of over $600 million, but this
statistic is slightly misleading. This is because the Dominican
Republic, which tops Japan in this category, is merely a major
assembly point for U.S. apparel and not a major market. The
goods are assembled there in a low-cost environment but are
transported abroad and sold in other countries. Thus, Japan is
in reality the largest market for U.S.-made apparel products.
Market Characteristics and Current Growth. As a result of
the economic recession in Japan over the last several years,
the average annual growth rate for apparel in Japan has only
been a meager 2 to 3 percent, but imports from the United
States have been increasing at an annual rate of 11 percent.
This large growth is due to the boom of ‘‘American casual
fashion’’ in Japan.
In the past, Japan closely followed European fashions,
especially Italian fashions. However, today many Japanese
prefer American fashions, in particular, casual apparel. Sports-
related products such as T-shirts, sweat suits, and clothing with
professional sports team logos are particularly popular, and so
are jeans, outdoor wear, and any items with a casual, uniquely
668 • Case 8 • Gap Inc.
American look. Individuals in the 15- to 25-year-old age group
follow U.S. fashion trends closely. However, women’s wear
and children’s clothing wear in the United States are not
gaining popularity quickly and are facing difficulties in the
Japanese market.
Another trend in the Japanese market, and indeed in all
sectors of business, is the growing tendency of consumers
to demand ‘‘value.’’ Consumers are noticing that Japanese
prices are much higher than those of comparable industrial-
ized countries. (Japanese consumer prices average 40 percent
higher than those in the United States.) Consumers still want
high quality but are also demanding lower prices.
Growth Projections. According to the U.S. Department of
Commerce International Trade Administration, apparel was
the thirteenth best prospect industry sector in Japan for U.S.
exporters in 2000. Analysts predict that the overall Japanese
economy, which has been in recession until recently, will
improve, but consumers are likely to be more cautious about
spending money. This is in line with the growing trend toward
‘‘value.’’ The apparel market is expected to continue growing
at 3 percent, but import growth is expected to increase. Japan
has a very high level of receptivity to U.S. goods, not much
local and third-country competition, and almost no market
barriers to entry. For Gap Inc., this indicates a favorable envi-
ronment. However, the distribution system in Japan is the
main obstacle to market entry and may pose major problems.
Business Environment. The domestic market is very com-
petitive, and consumers are highly brand conscious. Long-
standing, close-knit relationships between individuals and
firms are very important in business operations. Local business
practices are very traditional, and foreign company partici-
pation is not considered important. A long-term approach is
essential for U.S. companies in Japan to develop the necessary
business relationships and show a willingness to contribute to
the local business community.
Business Attitude Toward the U.S. and Exit/Entry Barriers.
Japan has a positive attitude toward U.S. suppliers, and many
U.S. companies have established reputations in Japan for
high-quality, reasonably priced products. However, some U.S.
companies are still finding it difficult to overcome traditional
Japanese attitudes toward foreigners as being ‘‘outsiders.’’ In
the past, Japanese laws and regulations prevented many U.S.-
based companies from entering Japan after World War II. The
result has been little interaction until recently, and Japanese
companies are hesitant to trust American firms. Officially,
Japanese government policy is to promote imports and inter-
national business interaction, but traditional business attitudes
are making this difficult.
It is also difficult for many U.S. companies to be accepted
as business partners by Japanese companies that are bound
by keiretsu ties that prevent them from doing business with
non-keiretsu companies. If a Japanese company that is part of
the country’s keiretsu is qualified in a particular business area,
it will be chosen over a U.S. company. This is a significant
barrier to market entry in Japan.
The most formidable obstacle for U.S. companies to over-
come in Japan is the traditional distribution system. The
keiretsu system controls many of these distribution networks
and long distribution channels in which all participants must
purchase from and sell to each other. As a result, U.S. compa-
nies cannot easily get into a distribution system.
Competitors and Substitutes. Competition in the apparel
industry comes mainly from low-cost Asian companies that
also have the advantage of easy access to Japanese markets.
However, U.S. brand image is very important, and Asian
products are considered low quality. European companies
provide some competition, but this is mainly in the area of
high-end brand name and designer clothing. Japanese com-
panies’ competitiveness is eroded by the high manufacturing
costs resulting from the strong yen.
Substitutes in the form of low-price discount retailers are
becoming increasingly prevalent in Japan. They could pose a
threat to higher-priced apparel stores such as The Gap and
now Banana Republic.
Government Regulation and Controls. There is an incredible
amount of government regulation in the Japanese business
environment. This is mainly in the form of licenses, permits,
and approvals that are required to do business. These licenses
often take a long time to process and are somewhat of a barrier
to market entry. In addition, ‘‘administrative guidance’’ papers
(informal edicts issued by government officials to companies)
are used to control foreign companies and restrict market
entry. Although the Japanese government has removed most
of the legal and administrative restrictions on foreign business
activities in Japan, anticompetitive and exclusionary business
practices still exist at lower levels of government. However,
the government is actively seeking ways to increase foreign
investment and imports.
CONCLUSION
As Gap Inc. continues to expand into the foreign markets, it
should consider several options to reduce costs and thereby
increase profit. First, because Gap Inc. does not produce
or procure merchandise in any of the foreign markets it is
currently in, establishing free-trade zones in those countries
might help increase profits by temporarily reducing duty and
VAT costs, and no duties would be paid on extra merchandise.
Second, attention should be paid to centralizing advertising
to reduce cost. Third, the problems associated with sourcing
from so many different regions should be considered and
ways found to correct them. Finally, Gap Inc. should seek
ways to take advantage of the many free-trade agreements
that recently have been signed.
DISCUSSION QUESTIONS
1. Gap, Inc., conducts sourcing from 700 different sources
both domestically and abroad. What would be some of the
advantages for this type of sourcing strategy? What would
be the disadvantages?
2. How can Gap Inc. benefit from the free ports in the UK?
3. The North American Free Trade Agreement has benefited
many U.S. companies by reducing tariffs on NAFTA coun-
try goods traded between each other. How has this actually
benefited Gap Inc.? in the future?
4. Now that more U.S. companies are moving into Cana-
dian apparel markets, Gap Inc. is facing more and more

competition from apparel manufacturing companies from
its own country. How can it maintain its Canadian market
share?
5. In Canada there is a recent trend of consumers abandoning
their name brands and buying cheaper garments to save
money. What can Gap Inc. do to take advantage of this
new development?
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 9
MOTOROLA: CHINA EXPERIENCE
This news was unsettling but expected for Brian Lu, the
general manager of Motorola China’s Personal Communi-
cation Sector. He had just received a report on the most
updated market analysis. The report was on intensifying mar-
ket competition in the Chinese cellular phone industry and
stressed the emerging Chinese brands, among which TCL is
the current leader. TCL is eating shares from all of the inter-
national brands, including Motorola. He knew the Chinese
government’s policy of promoting local companies over their
international counterparts, and this report confirmed a fear
that he had had since he was promoted to his current position.
Brian understood that Motorola, as the number one foreign
import/export company in China, was in a unique situation.
Through the creation of complete locally sourced production
and development, Motorola had established a strong infra-
structure and developed powerful relationships in China. He
now wondered, what was Motorola’s best strategy to take
advantage of their company’s previous development? The
company needed a plan of action, and he decided to arrange
a meeting to discuss how Motorola should react to these local
brands and overall market competitive pressures.
COMPANY BACKGROUND
Motorola was founded by Paul V. Galvin in Chicago, Illinois,
in 1928. Under the leadership of Robert W. Galvin, Paul’s son,
Motorola expanded into international markets in the 1960s
and began to switch its focus from the previously dominant
consumer electronics market it had targeted. The company
sold its color television receiver business, which then allowed
it to concentrate energies on high-technology endeavors in
commercial, industrial, and government fields. By the end
to the 1980s, Motorola had become the leading worldwide
supplier of cellular phones. Following a merger with Gen-
eral Instrument Corporation, Motorola became a leader in
cable modems and set-top terminals. This allowed the com-
pany to become a leader in chip system–level technology,
harnessing the power of wireless, broadband, and the Inter-
net. Motorola is the first company to offer wireless always-on
access to the Internet through its use of General Packet Radio
Service (GPRS) protocol technology. As an industry leader,
This case was prepared by Eric Berken and Yanhua Dai of the Fox
School of Business and Management and updated by Sonia Ketkar at
Temple University under the supervision of Professor Masaaki Kotabe
for class discussion rather than to illustrate either effective or ineffective
management of a situation described (2006).
Case 9 • Motorola: China Experience • 669
6. What steps should Gap Inc. take to combat ‘‘knock
off’’ items?
7. Gap operated around 20 stores in Germany until it sold
them to Swedish H&M in early 2004. Was the move nec-
essary, or could the company have considered some other
strategy?
Motorola has continued to grow, and in 2004 the company
had worldwide sales of US$31.3 billion.
MOTOROLA CHINA
Motorola entered China in 1987 when it opened its first office
in Beijing under the name of Motorola China Electronics
Ltd. In 1992, it set up the Motorola (China) Electronics
Ltd. in Tianjin and began to produce beeper-pagers, mobile
phones, two-way radios, wireless communications facilities,
semiconductors, automobile electronics, and so on. The prod-
ucts not only were sold in China but also were distributed to
world markets. Through its early production of beeper-pagers,
mobile phones, and two-way radios, wireless communications,
semiconductors, and automobile electronics, the company has
become the biggest foreign import/export company in China
(according to the Chinese edition of Fortune). Now Motorola
is the largest foreign electronic company, the largest Ameri-
can company. In 2003, Motorola was recognized as the foreign
investor of the year by CCTV television network.
Motorola China utilizes local sourcing in a ‘‘win-win or two
+ three + three’’ development strategy to make China its local
home and development base in Asia. Motorola’s China opera-
tions consist of 1 wholly-owned factory, 1 holding company, 8
joint ventures, 18 R&D facilities, and 26 sales offices. Motorola
China employs a total of 10,000 people 1,400 of whom are in
research and development (R&D). The company’s integration
and sales goals are driven by R&D centers, management train-
ing, and joint-venture partner assistance that have established
the company’s ability to develop, enhance, and distribute
products to local consumers. The overall goodwill created
by Motorola’s efforts to produce completely in China have
ensured the company’s continued development in China’s
complex consumer and business markets.
Motorola China’s specific ‘‘two + three + three’’ is the
company’s clearly defined approach for the future. The ‘‘two’’
means to turn China into both a global production base and a
R&D base of Motorola. Now, Motorola’s production base in
Tianjin has two parts: a semiconductor production center and
an Asian communications production base. Motorola has also
decided to build a research and development base in China,
taking Beijing as the center. In the five years following 2003,
Motorola expected to increase R&D fees by US$1 billion and
recruit 4000 research fellows. By that time, Motorola’s total
R&D investment in China will reach US$1.3 billion. The first
‘‘three’’ means three times US$10 billion: by the end of 2006,
670 • Case 9 • Motorola: China Experience
an annual output value of US$10 billion in China; by the end
of 2006, a total investment of US$10 billion in China, including
investment from strategic business partners like joint-venture
partners and suppliers; and an accumulated US$10 billion pur-
chasing of accessories and services from China in the coming
five years. The other ‘‘three’’ means laying great emphasis
on the development of digital trunking and iDEN, semicon-
ductors, and broadband besides wireless communications, and
making the three operations the new profit-increase points of
Motorola.
Motorola has taken various measures to implement the
‘‘two + three + three’’ strategy, including adjustment of the
company’s worldwide manufacturing capacity, the decision to
increase R&D investment in China, the establishment of a
software center in Chengdu, and plans of the Energy Sys-
tems Group to establish its Asian design and procurement
headquarters in Shanghai.
A major factor in Motorola’s expansion is its utilization
of joint-venture partners to implement the infrastructure to
develop outlets for its products. Joint contracts with China
Mobile and companies like Cisco and Nortel Networks have
allowed Motorola to expand into the vast Chinese markets.
These contracts have given Motorola access to 21 Chinese
provinces of which 14 have contracts to deploy Motorola’s
systems and municipalities including Beijing, Tianjin, Zhe-
jiang, Sichuan, Hunan, Jiangxi, and Liaoning. These ventures
allow the company to focus on its expertise in developing
and distributing cell phone technology and products while the
network infrastructures are handled by other companies with
expertise.
Motorola is currently the industry leader in China based
on its first-mover status. Motorola entered China at a prime
time when mobile communications was still a novel idea and
no one was selling it. As a result, the company enjoyed ten
years of success in selling its pagers as tens of millions of
Chinese, at that time, wanted to carry one for convenience
and as a symbol of social status. Riding on that momentum
and a strong emphasis on design and marketing, Motorola’s
handsets hold the largest market share in China (estimated
at 28.9 percent) as its brand is often associated with best in
quality, features, and form factor. China is arguably the most
important market in the world for Motorola, as Motorola has
been less optimistic about its future in the rest of the world.
For these reasons, Motorola has announced plans to increase
investment in China to $10 billion (cumulative) by 2006. In
China in 2003, stood at $3.4 billion and sales were $4.67 billion.
MARKET STRUCTURE
The Chinese government regulates and implements its
national telecommunications infrastructure through China
Telecom and the China United Telecommunications Corpora-
tion (UNICOM), both of which are state-owned corporations.
This duopoly market is still closed to foreign wireless service
providers, such as AT&T. Because the government-controlled
China Telecom and UNICOM do not have a large motivation
to explore the market, they either charge new subscribers
high initial fees or provide prepaid wireless service to con-
sumers. This strategy makes cell phone usage somewhat less
attractive to consumers, even though the initial fee has been
dropping from as high as US$1000 ten years ago to the current
rate of US$50. This has caused cell phone manufacturers to
promote their products independently rather than bundle the
cell phones with wireless services.
The cellular phone industry in China is going through the
growth stage of the industry life cycle. As the country’s market
continues to grow rapidly, barriers to entry are being lowered,
for the government and its people want to assure the advance-
ment of the industry. Overall, the market is currently at around
350 million subscribers, number one in the world. This is cur-
rently only a 13.9-percent penetration rate, which is lower
than average, as compared with all other major cell phone
markets. This early industry life cycle stage’s strong growth
potential is what makes China such an attractive market for
expansion.
The geography and buyer power of the market, though
initially centered in the east, is expanding throughout China.
Wealth plays a key role in the current distribution of sales,
as the eastern region accounts for 53.8 percent of China’s
current sales. However, the central region at 22.5 percent and
the western region at 23.75 percent are rapidly expanding,
giving distributors opportunities to enter fresh markets over
the next decade.
Distributors. These are the sources for companies to deliver
their products throughout the market. The primary distribu-
tors are the state-funded network and the larger distributor
networks throughout the Asia Pacific. A government net-
work sponsored by China Mobile is a key network as it
sells and distributes other brands. Another strong channel is
made up of companies like CellStar and Bright Point, which
are the world’s leading global providers of innovative, value-
enhancing logistics services to the wireless communications
industry. Another channel outlet is the smaller, private, exclu-
sive distributorship agreements, on which Motorola does not
heavily depend. These partner combinations are important
for companies that depend on them to get their products to
the ever-expanding market regions.
Wireless Service Providers. The two service providers for
wireless access in the Chinese market are China Mobile,
which provides 69 percent of service; and China Unicom,
which provides the remaining 31 percent of service. China
United Telecommunications Company, Ltd. was formed in
1994 under a government directive to break up the monopoly
held by China Mobile. In May 2002, the government ordered
old China Mobile to break up into two operating entities;
where China Mobile would retain the original corporate iden-
tity and operate in 21 provinces and municipalities in south
China. Despite this apparent attempt by the government to
strengthen competition in the market, both have strong gov-
ernment ties. These ties, and the duopoly created by this
situation, have resulted in a lack of competition that has led
to severe price imbalances for consumers. Because of their
dominant positions, it is imperative that cell phone distrib-
utors form an alliance with these providers to enhance the
distribution of their products.
Retailers. The retail distribution for the cell phone is severely
fragmented but is consolidating with industry growth and
expansion. As mentioned previously, because of its dominant
position, China Mobile serves as a major distributor for cell
phone technology producers. Major department stores and

retail outlets (e.g., Tristar) provide other key outlets for dis-
tribution. There is no one way to get products to consumers,
for no one company has access to all of the markets in the
nation; providers must therefore develop relationships with
many types of outlets in order to gain market advantage. This
is changing as the larger outlets and suppliers are buying up
smaller retailers to consolidate their retail capabilities.
COMPETITION
Because of the large size of the Chinese cell phone market and
its potential for long-term continual growth, competition for
access to China’s consumer markets is intense. Competitive
threats from Nokia, Siemens, Samsung, and local producers
like TCL are a cause for concern within Motorola. How-
ever, 84 percent of Chinese consumers prefer foreign mobile
phones to local models, with Motorola, Nokia, and Ericsson
being their favorite makers, according to a nationwide sur-
vey conducted by the China Telecommunications Association
and Eaglewings Public Relations. For this reason, Motorola’s
biggest competition for cell phone supremacy would likely
appear to come from foreign companies outside of China.
China’s aforementioned government structure plays an
interesting role in the assumption that foreign companies will
maintain dominance. As is traditional, the socialist govern-
ment hierarchy prefers that a majority of any industry have
local majority control. The government, which controls the
operations of the service provider sector and is a dominant
player in distribution channels as well, has the means to
make this goal a reality—quickly. For this reason, Motorola
must utilize not only shorter-term strategies to find a way
to grow market share, but also long-term change strategies
to find a way to compete with government-powered locally
owned firms.
Nokia. Nokia of Finland opened its first office in Beijing in
1985. By the end of 2001, Nokia invested a total of 2.3 billion
euros (nearly $2 billion) in China and established itself as
a leading supplier in the handset market. By 2004, Nokia’s
sales in China were up 44 percent on year to $3.6 billion. The
company has 22 local offices, 8 joint ventures and a research
center, with 5,500 employees. Nokia was the second largest
handset supplier in China after Motorola, with a 25.7 percent
market share as of 2003. By the end of 2004, it had overtaken
Motorola as the leading handset provider. Nokia has definite
strengths in design and R&D with major economies of scale
EXHIBIT 1
MARKET SHARE OF CHINESE CELL PHONE MARKET
(AS OF 1ST QUARTER, 2005)
Local Chinese
Firms
47%
Samsung Motorola
10% Nokia
Samsung
Siemens Local Chinese Firms
Nokia Motorala 3% Siemens
22% 13%
Others
Case 9 • Motorola: China Experience • 671
benefits due to its world market leadership. It has used this
leadership to quickly develop a relationship with major dis-
tributors in China. A major drawback appears to be that the
standardization benefits it enjoys do not reflect the interest in
new differentiated products that consumers want out of new
growth products.
Samsung. In 1997, Samsung was selected to supply test
CDMA systems in Shanghai. Since then, the Korean company
has begun its expansion into the telecommunications mar-
ket. Samsung’s core competence is in three areas: research
and development (R&D), manufacturing, and sales and mar-
keting. Product leadership is established through vertical
integration and strategic alliances. Samsung wireless products
enjoy a unique synergy through vertical integration within
the Samsung Group. This synergy results from leading-edge
components available from the Samsung Group’s sister com-
panies, including Samsung Electro-Mechanics and Samsung
SDI. In addition, synergy is enhanced by sharing internal
resources with Samsung Semiconductor, Samsung Multime-
dia Division, Samsung Telecommunication Systems Division,
and others. Samsung is an extremely diversified company and
does not maintain a clear focus on cellular phone products in
particular. By the end of 2004, the market share for Samsung
and Motorola was almost the same; both firms were vying for
the second spot after foreign market leader Nokia.
Siemens. Siemens began selling telecom products to the Chi-
nese as early as 1972 (a manual telegraph receiver). In 1994,
this German company began its formal China operations
with products and services in communications, automation
and control, medical equipment, energy, power transmission,
transportation, and lighting. Siemens China provides sales,
human resources, purchase, financing, and strategy develop-
ment for its diverse businesses, which include telecom products
and related services. Together, Siemens China has more than
40 manufacturing facilities and 28 local offices; it has invested
more than $500 million in China (total) and employs 21,000
people. Sales for the 2001 fiscal year totaled 3.5 billion euros
($3.2 billion), up 49 percent from 2000, in which revenue
from mobile communications equipment was 13.5 billion yuan
($1.6 billion), according to the latest information. The com-
pany invested $250 million in 2002–2003 to expand R&D
centers in Beijing, Shanghai, and Singapore. However, in 2004
and early 2005, Siemens was experiencing falling market share
672 • Case 9 • Motorola: China Experience
and the company denied rumors that it would exit the Chinese
cell phone market.
Ericsson. Ericsson of Sweden began selling in China as early
as 1892. It returned to China in 1985, and formed limited
China holdings in 1994. To date, Ericsson has 10 joint ven-
tures, 4 wholly-owned subsidiaries, and 26 sales offices in
China, employing some 4500. According to the company, its
investment in China exceeds $600 million and as such is one
of the largest among foreign telecom companies. Since 1998,
China has become Ericsson’s single largest market in the
world, with annual sales (including export) estimated at $1.7
billion. Ericsson has become deeply involved in China, as the
telecom market in the world is slowing down and competi-
tion is fierce in sectors such as cell phone handsets while the
China market is still growing rapidly. Ericsson’s handset sales
in China, once a flagship for the company, has been in sharp
decline since 1999 owing to strong competition and more selec-
tive customers. In August 2001, Ericsson and Sony formed a
joint venture for handset manufacturing, which would fill the
void Ericsson left in handset manufacturing in China. Ericsson
has positioned itself to attain new sales by focusing its adver-
tising on young females demographically and by distributing
products with more advanced specialized features. Ericsson
appears to be focusing on niche marketing for cell phones
because of its overall lack of a company-specialized focus
for the cell phone market. For now the small salesforce that
Ericsson employs in China seems to be comfortable with its
smaller niche positioning.
EXHIBIT 2
GROWTH IN SUBSCRIBER BASE
400
350
300
Subscribers (In Million)
250
200
150
87.6
100
43
50 24
12
0
1997 1998 1999 2000
Year
Locals and Others. Here is where we encounter competitive
pressure coming from smaller local firms championed by the
government. With over 33 percent of the market in 2002,
which soon increased to over 40 percent by the end of 2004,
coming from these firms and with local medium-sized players
like TLC at 6.8 percent, competition is fierce and severely
fragmented. Motorola had kept an eye on these producers in
the past, as the threat of competitor buyouts and consolida-
tion had always been a concern. Now, Motorola is faced with
the more imposing threat that, with government support, the
smaller local brands could take away the company’s dominant
market position.
Motorola’s Competitive Adjustment
CCID, a consulting firm under the Ministry of Information
Industry, showed that Motorola had a leading market share of
28.7 percent in the mobile phone industry in 2002 but by 2004,
Nokia had surpassed Motorola’s market share. Market ana-
lysts attribute this success to the company’s brand reputation,
flexible product strategy, and considerate after-sales service.
Through the launch of high-quality stylized phone products
and Total Solution Service Centers in every major city market,
Motorola has positioned itself as a desired local product brand
that provides optimal value throughout its relationship with
customers. The company knows that there is no guarantee
of continued market leadership, but it feels that by creating
such a strong market infrastructure, it has positioned itself in
the Chinese market for the long haul. Motorola continues to
feel that its decision to produce locally and to develop strong
320
260
220
144
2001 2002 2003 2004

bonds with local suppliers and distributors is its best bet to
maintain a strong position in the country.
CONSUMERS
By the end of October 2002, China became the largest cellular
market in the world, with a total of 180 million cell phones
in use. The number reached 220 million by the end of 2002
and 353 million by early 2005. According to data from China
Mobile and China Unicom, the cumulative number of sub-
scribers increased by an annual rate of more than 50 percent
from 1998 through 2002.
The stereotyped image of the cell phone owner (‘‘affluent
boss’’) has long ago faded. Although this may describe one
of the segments still targeted by cell phone manufacturers,
today’s user symbolizes the blending of tastes, preferences,
and meanings associated with products crossing several demo-
graphics and psychographics boundaries. A discussion of the
four market segments that define today’s cell phone user
follows.
Heavy Users. They are successful entrepreneurs, business-
men/women, and professionals over 30 years of age, with high
income. People in this segment view cell phones as a necessary
tool for their jobs. Most of them are early adopters of mobile
phones. It is easy for them to stick to one brand because they
are unwilling to spend time in getting used to new menus.
Therefore, this segment is much more loyal to certain brands
with reliable quality, compared to the other three segments.
They are willing to pay extra money for high quality.
Technology Enthusiasts. This segment is male dominated,
highly educated, and aged between 25 and 45. They are eager
to try every high-tech gadget, and they always seek new
cell phones with either cutting-edge technology embedded or
unique functions. Consumers who fall into this category are
more likely to try some fantastic accessories connecting cell
phone and other personal digital devices, such as laptops and
personal digital assistants (PDAs), as well as take advantage
of the wide usage of wireless access to the Internet.
Fashion Seekers. Most consumers in this segment are young
females aged 20 to 40 who love trendy apparel and can
afford it. They care more about the appearance of the cell
phone, such as shape, size, and color, than about its diversified
functions. TV commercials featuring appropriate celebrities
usually have a significant influence on the purchase behavior
of this segment. Both this segment and technology enthusiasts
have a propensity for changing their phones frequently. There-
fore, products targeting these two segments have a relatively
shorter life cycle.
Social-Life Lovers. This is not a ‘‘richer’’ segment. With
regard to demographics, these people are consumers with
average income, are either men or women, and are without
age limit. They like to make friends, and they care about their
families. The cell phone is a perfect tool for them to keep in
touch with both friends and family members. However, they
may not be attracted to cell phones with comprehensive and
sophisticated functions at relatively higher prices. People in
these segments are much more price-sensitive than those in
the above three segments. They usually have the patience to
Case 9 • Motorola: China Experience • 673
wait for sales promotions in order to get good deals. From
this point of view, the profit margin of cell phones targeting
this segment is the lowest in the four categories. However,
with the increasing number of people owning a cell phone,
this segment is expanding rapidly and is contributing more to
the growth of the entire market size.
MOTOROLA’S STRATEGY
When wireless service became available in 1987, Motorola
was the sole provider of both network equipment and cell
phones based on analog technology. As the first company to
introduce the concept of mobile communication into China,
Motorola has been enjoying solid brand recognition in this
market.
Entry Mode—Greenfield Operation. Viewing China as an
emerging market with great potential, Motorola chose the
‘‘greenfield operation’’ as its entry strategy when it set up the
first office in China in 1987. The rationale behind this choice
of entry mode can be described as follows:
First, Motorola’s pursuit of an overall global strategy
decides a high-control entry mode. Since the cell phone indus-
try is highly concentrated, with a limited number of players
who confront each other in many different national markets
around the world, a wholly-owned foreign subsidiary allows
for Motorola’s global strategic coordination.
Second, because of the relatively low investment risks
in China, Motorola chose the greenfield operation, which
involves substantial resource commitments. Since China
reopened its economy to foreign investors in 1979, the country
has been gaining experience in attracting foreign investment.
Investment incentives and infrastructure supports in Special
Economic Zones and open cities (including Tianjin where
Motorola’s wholly-owned factories are located) motivate for-
eign firms to adopt high-control equity-based entry modes.
Finally, although the demand for mobile phones in China
was low in the first few years, market potential was great in
terms of the country’s huge population and increasing con-
sumer purchasing power, especially in cities along the coast.
Since at that time the cell phone had been newly introduced
into the Chinese market and the rapid growth period did not
start until a few years later, Motorola had enough time to
establish a wholly-owned subsidiary from scratch.
Since being established in 1992, the manufacturing plant in
Tianjin (a port in northern China), which is 100 percent owned
by Motorola, has become one of the major global production
bases in the world for personal communication products,
including the cell phone. Motorola’s initial time and capital
investment in the factory has already paid off. The Tianjin
factory not only provides products to the Chinese market
and other countries in Asia but also consolidates Motorola’s
relationship with both central and municipal governments; as
the factory has been one of the 10 companies with the largest
exports and sales since 1994.
Operation—Localization Strategy. Knowing that consumer
preference in the Chinese market is quite different from that
in the U.S. market, Motorola started to localize its prod-
uct development after the initial poor performance of pure
‘‘global’’ strategy. Now Motorola adapts its models to meet the
specific demand from local markets rather than simply throw
674 • Case 9 • Motorola: China Experience

EXHIBIT 3
ADVERTISING AND PROMOTIONS TARGETED TO MARKET SEGMENTS
Attitudes Sub-brand Advertisings and Promotions

Heavy Users Working hard; high-quality Timeport Print ads placed in upscale business
consciousness when magazines such as Business Week
purchasing. (Chinese edition).
Direct marketing such as sponsoring
golf club.
Fostering positive word-of-mouth.
Technology Heavy user of the Internet. Accompli Editorials in magazines.
Enthusiasts Aspiring to get ahead. Internet marketing, including the
design of Motorola’s Website.
Fashion Seekers Enjoying life rather than living V. Chinese supermodels and pop music
frugally. singers as representatives for this
serial.
Associating brands with role TV commercial.
models such as celebrities. Print ads in fashion magazines such
as Elle and Cosmopolitan.
Social-Life Lovers Willing to pay for top brands, TalkAbout Cooperating with wireless service
but will also wait for price providers to offer discounted
drop. initial fee.
Yield easily to sales Sales promotions offering extra
promotion. accessories, such as one more
battery, or gifts.

the current products into the market without any adjustment.
The R&D center in China successfully developed software to
show the menu in Chinese and to input Chinese characters.
In 1999, a combination PDA/phone, which was designed by
Chinese engineers, was launched in China and spread to the
United States and Europe.
Motorola’s localization strategy also includes local sourc-
ing. The company takes the initiative in establishing rela-
tionships with local suppliers. Seven years ago, 65 percent
of components were imported, whereas 69 percent of com-
ponents are now purchased locally. Local sourcing brings
Motorola three major benefits: lower manufacturing cost,
reduced risks from currency fluctuation, and ability to cater to
the Chinese government’s requirements.
Marketing Segmentation. With regard to branding strategy,
Motorola introduced four subbrands to respectively target
the four market segments: Timeport to Heavy Users, Accom-
pli to Technology Enthusiasts, V. to Fashion Seekers, and
TalkAbout to Social-Life Lovers. Different advertisements
and promotions are implemented to target these four specific
categories, shown in Exhibit 3.
Although Motorola markets four cell phone serials in dif-
ferent ways to target different consumer groups, the company
does not invest a lot in building the brand recognition of four
subbrands. The names of subbrands only appear on the labels
of the phones. Most consumers do not seem to pay attention
to the subbrands when purchasing.
DISCUSSION QUESTIONS
1. How should Motorola appropriately react to the emerg-
ing local brands, head-to-head competing or cooperating
in some fields? Will licensing manufacturing technology
to Chinese manufacturers weaken Motorola’s core compe-
tency?
2. Facing the expanding low-priced segment, how should
Motorola, traditionally known as a brand for high-end
mobile phone, position itself? Is the company’s current
branding strategy effective in penetrating this segment?
If not, what kind of marketing strategy should Motorola
follow?
3. What should Motorola do in order to effectively cut cost in
developing a low-priced mobile phone?
 Case 10 • iPod in Japan Can Apple Sustain Japan’s iPod Craze?
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 10
iPOD IN JAPAN CAN APPLE SUSTAIN JAPAN’S iPOD CRAZE?
INTRODUCTION
On January 12, 2005, Apple Computer, Inc. announced rev-
enue of $3.49 billion and a net profit of $295 million for its
fiscal first quarter that ended December 25, 2004. This was the
highest quarterly revenue and net income in Apple’s history.
These were surprising and serendipitous results for Apple
given that as late as 2002, critics wondered if Apple could turn
waning market share and losses back around again. From its
Apple IIe glory days of the 1980s to its crippling loss of PC
market share in the 1990’s, Apple has certainly experienced
its share of ups and downs.
Enter iPod.
During the last quarter of 2004, while Mac unit growth rose
26 percent, iPod experienced 525 percent unit growth. During
the same quarter, Apple shipped out over 4.5 million iPods.
As of Apple’s press conference in January 2005, Apple had
sold over 10 million iPods. iPod has single-handedly revital-
ized Apple’s business, totaling $1.21 billion in sales, or a third
of its total revenue, in the first quarter of 2005.
Apple has completely reversed its fate and revived its
global brand equity with the introduction and smashing suc-
cess of its iPod family of products, namely iPod and iPod mini,
but not excluding iPod Shuffle, iPod Photo, and a myriad of
iPod accessories. In the process, Apple has taken the music
electronics industry by surprise by creating a stylish standard
in music players that speaks to the savvy music consumers who
desire to make a fashion statement while digitally organizing
their tunes.
In Japan, iPod has enjoyed record sales and its ‘‘halo effect’’
has even boosted revenues on other Apple products, such as
iMacs and iBooks. With its small, cute shape and trendy col-
ors, the iPod mini has rocked the portable music player scene
with an average of 5,000 visitors to Apple’s Tokyo Ginza store
each day. Apple’s global brand equity has skyrocketed, as
iPod has become a high-end fashion statement able to hold
its own with the likes of Prada, Coach, and Louis Vuitton.
More importantly, iPod has become the product that defines
the digital music player.
Apple currently sits atop the peak of its iPod success in
both the U.S. and Japan. But in the fast-moving industry of
electronic gadgets, can Apple sustain its success? Next gener-
ation, music-minded cell phones, new MP3 players, and other
multimedia devices, such as the Sony PSP, are hot on iPod’s
trail. Can Apple keep the lead? More importantly, is the suc-
cess of iPod and iPod mini in Japan just a fad? Is the iPod
craze in Japan sustainable?
Laura Samartin, Heather Vespestad, and Tony Wu from the Japan-focused
MBA Program at University of Hawaii at Manoa prepared this case under
the supervision of Professor Masaaki Kotabe, solely as the basis for class
discussion (2005). The case is not intended to serve as endorsement, sources
of primary data, or illustration of effective or ineffective management.
• 675
HISTORY OF APPLE
The United States
Like the legend of Microsoft, most people are familiar with the
story of the founding of Apple Computer. High school buddies
Steve Wozniak and the now infamous Steve Jobs sparked the
personal computer revolution in 1976 that would later usher
in formidable competitors, like IBM and Bill Gates. By the
mid-1980s, Apple had 20 percent of the PC market share in
the U.S. But while Apple and Jobs refused to allow Apple-
compatible computers, IBM(PC)-compatibles and Microsoft
OS flooded the ever-expanding PC market and gobbled up 75
percent of Apple’s market share throughout the 1990s. By the
end of the decade, Apple had a mere 5 percent of the total PC
market share.
In 1998, after a brief hiatus, Jobs returned to Apple and
focused on a new generation of Macintosh and creating the
‘‘i’’ concept. The fruits of Jobs’ labor brought Apple back
on the map when the trendy design and technological ease
of the iMac and iBook won consumers over both at home
and abroad. The rebound was temporary, however, as Apple
experienced slow sales in 2000, both due to an industry-wide
slowdown, as well as the unexpected failure of the iCube,
Apple’s latest hardware innovation at the time.
In 2001, Apple opened its first retail store in the United
States and soon stores popped up all over the country.
Although Apple released new versions of iMac and iBook
in 2002, sales still remained stagnant and limited to existing
Apple users. It was not until the recent iPod craze that Apple
was able to explore uncharted markets and reach a broader
range of customers on a different common ground—music.
Once again, Apple miraculously skirted defeat with this bold
maneuver.
Japan
Due to its domestic success in the late 1970s, Apple was
interested in expanding its sales of the Apple IIe to inter-
national markets, notably Europe and Japan. Apple entered
the Japanese market through an arrangement with a Japanese
distributor who was an acquaintance of Steve Jobs. Due to
inadequate distribution of non-localized Apple products at
extremely high prices, few Japanese consumers had access to
or could afford Apple’s products. A high level of corporate
arrogance also contaminated Apple’s entry in Japan. As a
result, Apple’s first attempt to enter Japan’s market failed
miserably and was even used by the U.S. Department of
Commerce as a case study to illustrate how not to enter the
Japanese market.
By the 1980s, however, Apple committed to its presence
in Japan and stepped up its efforts to localize its products
with Apple Technologies, a joint R&D operation with Apple
Japan. The distributor network was also expanded and Apple
made considerable efforts to develop brand awareness. By
1999, largely due to the success of the new iMac and iBook
in Japan, Apple was able to capture 23 percent of overall
676 • Case 10 • iPod in Japan Can Apple Sustain Japan’s iPod Craze?
PC market share in Japan. Furthermore, 9 out of the top ten
desktop sales were Apple computers and 3 out of the top
ten laptop sales were Apple laptops. Apple did not open its
first retail outlet in Japan until it unveiled the iPod mini at its
Ginza store in 2003.
iPOD MANIA
Domestic craze
In 2001, Apple introduced a departure from its PC products
that ventured into the music industry: iPod. The largest hard-
drive music player in the U.S. at the time, the first iPod had a
5 GB hard drive and sold for $399. It was an instant hit in the
marketplace, especially with loyal Apple users. In July 2002,
Apple introduced Windows-compatible software for the iPod
and its market immediately multiplied ten-fold. By that time, a
third-generation 20 GB iPod had been revealed for $499, and
the previous generations were discounted by $100. New pro-
motional campaigns, including iPod’s trademark commercial
featuring dancing silhouettes with white earbuds, transformed
the need for a digital music storage device into a genuine desire
for a trendy, fashionable portable music player. In April 2003,
iTunes Music Store (iTMS), Apple’s online (and legal) music
download site, was opened. Since then, Apple has sold more
than 300 million song downloads through iTunes Music Store.
By the time iPod mini was introduced in January 2004,
iPod and iPod accessories were already all the rage. The 4 GB
‘‘mini’’ iPod came in eye-catching, metallic colors of silver,
blue, pink, green, and gold and was smaller than most cell
phones in the U.S. Selling for only $249, it was also a much
more economical purchase than its big brother, though most
iPod-addicted users scoffed at the small memory size. The
second generation of iPod mini, which debuted in February
2005, sells for the same price, but has a 6 GB capacity; 2 GB
more than its first generation predecessor (which now sells for
$199). Again, the iPod mini helped Apple access a broader
range of customers in terms of budgets and tastes.
By 2004, iPods and iPod minis held a virtual monopoly in
mass-storage music players, capturing 87 percent of the HDD
music player market in the U.S.
To date, iPod and iTunes are improving Apple’s brand
recognition at home and abroad, as well as its overall position
in the home computing market. According to financial services
firm Piper Jaffray & Co., 6 percent of Windows users in the
U.S. who own iPods have switched to iMacs, and 7 percent
more plan to make the switch.
Not so ‘‘mini’’ success in Japan
Approximately 1,500 people in Tokyo, and over 2,500 people
in Osaka lined up outside the Apple Store in Japan on August
28, 2004, the release date of the iPod mini. Demand for the
mini has far surpassed its supply, with some customers waiting
up to six weeks for their iPod mini.
Some have described the iPod mini as an ideal product
for the Japanese market. ‘‘It is a product that does something
useful, does it really well, and looks terrific too.’’ Its slick
design, limited-supply marketing, carefully designed stores,
and its award-winning advertising campaign are the reasons
behind iPod mini’s incredible success in Japan.
Apple has launched a marketing campaign in Japan with
catchy TV ads and billboards painted on Tokyo trains. Apple’s
award-winning TV ads feature silhouettes dancing to up beat
music; music that has caught just as much attention in Japan
as iPod mini itself; music that has prompted many consumers
to ask just who are those artists. Before and after the grand
opening of Apple’s store in Tokyo, poster ads could be seen
plastered all over train stations, train tunnels, and the actual
structure of the trains. In Tokyo, the Yamanote Line train
became a giant iPod bee-bopping around the busy heart of
the metropolis.
JAPAN’S APPLE STORES
A major part of iPod’s success in Japan is its Apple Stores.
The Ginza store, Apple’s first retail location outside of the US,
is situated near such high-end stores as Louis Vuitton, Coach,
and Chanel, a location that is very different from the tradi-
tional electronics center in Akihabara. Placing its stores in the
high profile retail locations of Japan is a part of Apple’s new
campaign toward the young and the trendy. Apple’s second
Japanese store is located in Osaka’s fashionable Shinsaibashi
area, its new London store is on Regent Street, and its New
York store is in the trendy SoHo district. At its grand opening
in 2003, the Ginza store attracted a long line of over 5,000
people that wound around the glittery stores and streets of the
Ginza district with the end of the line located several blocks
from the actual store. The Ginza store made 100 million yen
in sales in its first week of business, and is currently averaging
5,000 visitors per weekday. Apple opened a third store in
Nagoya this year and industry sources claim that Apple plans
to open 27 more stores in Japan in areas such as Shibuya
(western Tokyo), Kyoto and Umeda (Osaka).
Steve Cano, regional director for Apple Japan retail and
manager of the Ginza store, often visits the neighboring shops
to benchmark the Apple Store and its customer service. ‘‘I like
the (Apple) employees and how friendly and approachable
they are,’’ he boasts. ‘‘We don’t benchmark against computer
retailers, we benchmark against service leaders.’’
Key to Apple Store’s success is ongoing promotional activ-
ity held at its Japan stores. The program includes weekly,
evening performances by artists from local labels, and elec-
tronic musicians demonstrating how they use Macs to create
groovy music. Another crucial component is the popular
‘‘Genius Bar,’’ located on the first floor of the Ginza and Shin-
saibashi Apple Stores. The Genius Bar offers open forums that
provide Mac and iPod operating techniques and purchasing
advice from the Apple staff directly to customers completely
free of charge. The Genius Bar has proven to be a great suc-
cess. Many Mac fans wait hours to use the Genius Bar while
some even go so far as to make appointments for the services
at Apple’s Japanese web site ahead of time in order to avoid
the wait.
iPOD MINI SOARS, iPOD DOMINATES IN JAPAN
At the release of the iPod mini in 2003, the iPod family’s
share of the hard drive based music player market was over
72 percent. Independent reports also revealed that six of the
eight top selling music players in the overall Japanese market
were iPods. Buyers of the new iPod mini are not limited to
the traditionally gadget-obsessed Japanese male with a love
of music. Its customer base ranges from teenagers to busi-
nessmen in their 50s, and surprisingly, female customers. The
iPod mini comes in five stylish colors, pink, green, blue, silver,
 Case 10 • iPod in Japan Can Apple Sustain Japan’s iPod Craze? • 677

and gold, and is clad in sleek aluminum casing. The new case
color and material transformed the digital music player into a
fashion accessory for the Japanese consumer. Famous brands,
such as Fendi and Coach, are already offering iPod mini carry-
ing cases at couture prices. The iPod’s white earbuds are also
catching on as a fashion statement. Other MP3 player brands
and mobile phone manufacturers have already caught wind
of the trend, coming up with their own copy of the signature
white earbuds.
COMPETITIVE ENVIRONMENT
iPod’s direct competitors include the Sony Network Walk-
mans, the SONICblue Rio digital players, and iRiver digital
players. Sony, with its dominance in the walkman business
and reputation in Japan, is iPod’s biggest competitor despite
its late mover disadvantage for portable digital players. Sony’s
late entrance was further doomed after Sony only offered pro-
prietary Atrac3 software instead of the popular mp3 format.
Initially, Sony Music, which also owns Columbia Music, tried
to discourage Sony from promoting the Network Walkman, a
product that seemed to condone and encourage illegal down-
loading. In the fiscal year ending March 31, 2005, Sony experi-
enced a 30 percent decrease in its forecasted operating profits.
Both iRiver and Rio offer similar products to the iPod
line at a competitive price. Some of the variations of these
products are listed in Exhibit 1 below. Currently, iPod holds
over 50 percent of the market share.
DOWNLOADING SITES
The same companies competing for electronics sales are also
competing for digital music sales of downloaded songs to their
players.
iTunes Music Store is the online music downloading store
Apple officially unveiled in 2003 to complement its successful
iPod family of products. iTunes is predicted to reach 2 million
units sold by this summer, and is scheduled to launch in Japan
this spring. iTunes currently charges $.99 per downloaded
song.
Sony Connect, like its Network Walkman, is struggling as
it utilizes only its proprietary Atra3 software. The prices are
competitive, but higher than iTunes at around $2.00 or 250
yen per song.
Yahoo Music Unlimited is predicted to blow both Apple
and Sony away with their new subscription service. For only
$6.99 a month, subscribers can download unlimited music
(although some newer songs may cost extra). Currently,
Yahoo Music Unlimited in Japan offers downloads ranging
from 150 yen to 360 yen depending on the song. It has yet to be
announced whether they plan to offer the same subscription
service in Japan in the future.
There are several illegal file-sharing websites that Japanese
digital music aficionados use to obtain transfer free tunes onto
their mp3 players. Winny and WinMX are examples of two
sites used in Japan. Furthermore, Japan’s video rental stores
also rent the latest Japanese and American pop music CDs
to store customers, which are then usually copied by the
renting customer. These methods of obtaining free music in
a seemingly ‘‘legal’’ way in Japan are obstacles to the fur-
ther expansion and popularity of iTunes and other such sites
recognized as ‘‘legal’’ downloading sites.
NEXT GENERATION CELL PHONE THREATENS
IPOD DOMINANCE
All portable mp3 players, including iPod, are going to face
challenges as new, integrated gadgets and next-generation cell
phones are released in the next few years. Items like Sony’s
PSP player have video, game and music capabilities.
But industry big wigs like Bill Gates predict that music
players integrated with cell phones are going to be the down-
fall of iPod and its mp3 competitors. Approximately 1.4 billion
people in the world already own cell phones, which translates
to a huge, borderless distribution channel.

EXHIBIT 1
512 MB∼1.5 GB 2 GB∼6 GB 3 GB∼20 GB ABOVE 20 GB

IPOD SHUFFLE IPOD MINI IPOD IPOD PHOTO

1 GB 4–6 GB 20 GB 60 GB
$99–$149 $199–$249 $299 $349+

Sony Sony
NW-E105PS NW-HD3
512 MB 20 GB
$99.95 $299.95

Iriver IRiver iRiver

iFP-899 H10 H10
1 GB 5–6 GB 20 GB
$189.99 $249.99–$299.99 $399.99

SONICblue SONICblue SONICblue

Rio Nitrus Rio Carbon Rio Karma
1.5 GB 5 GB 20 GB
$169.99 $199.99 $220.00
678 • Case 11 • NTT DoCoMo: Can i-Mode go Global?
Currently, phones with mp3 functions are still in the testing
phase, but insiders say that the next generation of digital music
player hybrid phones could be out by 2008. Apple is aware
of the trend and trying to capitalize on iPod popularity by
teaming up with Motorola to develop an iPod phone. How-
ever, Verizon Wireless and Sprint, as well as many Japanese
carriers, are not willing to carry the phone. As Graeme Fer-
guson, director for global content development at Vodafone
Group PLC, points out, ‘‘It’s hard for people in any industry to
support something that cuts them out of potential future rev-
enue streams.’’ This may prove to be a major obstacle to the
success of an iPod phone. Especially in a cell phone saturated
market such as Japan, iPod will have to work even harder to
keep its dominance in the future digital music player market.
KDDI and NNT DoCoMo are both working on developing
phones that have hardware capable of significant music file
storage. In addition, many phones in Japan can now download
entire songs, as opposed to the traditional ‘‘chaku melo’’ that
contained only the first 30 seconds of a song.
FUTURE OF IPOD IN JAPAN
While iPod is selling by the millions, Apple’s global PC mar-
ket share actually shrank to less than 2 percent (1.87) in 2004,
largely due to large global competitors like Dell (18 per-
cent) and HP (16 percent). Apple has become increasingly
dependent on iPod’s continuing success both in the U.S. and
abroad.
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 11
NTT DOCOMO: CAN I-MODE GO GLOBAL?
INTRODUCTION
What’s next for i-mode? After its huge success with i-mode in
Japan, DoCoMo tried to bring the i-mode model to the U.S.
and European markets, but could not succeed. Although it
has over a quarter of the Japanese population as subscribers,
it is once again facing tough price competition in the domestic
market. Recently, it has formed new alliances with cell phone
companies in the U.S. and Europe. Can it succeed this time?
In May 2005, NTT DoCoMo announced that its annual net
profit in FY2004 rose 15 percent year-on-year to 747.56 billion
yen resulting from sales of its stake in AT&T Wireless, while
revenue fell 4 percent year-on-year. This implies that the main
business operation of the company is at risk and net profit
reported in FY2004 is non-recurring and not sustainable.
Some critics think DoCoMo is too technology-oriented and
allows too much time for new services to become profitable.
In 2005, DoCoMo unveiled a number of discounts, including
family plans and flat-rate data communications charge for 3G
Amornrat Cheevavichawalkul, Christina Okumura, and Amit Kanaskar
of the University of Hawaii at Manoa prepared this case under the super-
vision of Professor Masaaki Kotabe, solely as the basis for class discussion.
The case is not intended to serve as endorsement, sources of primary data,
or illustration of effective or ineffective management (2005).
Although iPod and iPod mini are currently dominating
Japan’s music player market, it remains to be seen whether
this ‘‘little white hope’’ can sustain its popularity continue to
have a true ‘‘halo effect’’ in Japan. While iPod has become the
standard for digital music players in Japan, it could prove to
be just another fleeting, consumer fad. Particularly troubling
is the uncertainty of iTunes in Japan as well as the foreboding
possibility of high-tech music-enhanced cell phones that could
render the iPod obsolete in the Japanese market.
One of the main reasons Apple has been successful in
Japan is its ability to constantly evaluate its products from the
Japanese consumer point-of-view and continuously launch
new and improved versions of its products while keeping
a half step ahead of the trend as well as its competition.
Clearly, Apple must continue to do just this in order to pro-
long its iPod honeymoon. Ultimately, whether or not iPod
can sustain its success in Japan and keep Japan as a major
profit center for Apple is as unpredictable as the iPod craze
itself.
QUESTIONS
1. How has iPod’s marketing strategy played a key role in its
success in Japan?
2. Is iPod’s distribution channel strategy effective?
3. What challenges will the integrated cell phone/mp3 player
present for iPod?
services in order to maintain a customer base. This resulted
in a reduction in profit margin. Also, it was revealed that
earnings will drop 33 percent due to increased competition.
Moreover, the Japanese government plans to grant licenses
for mobile networks to at least two new companies in 2005
and will introduce a rule in 2006 that will make it easier for
users to switch service providers. The company has also faced
additional risk factors such as measures to open up Internet
platforms and segment platform functions such as authenti-
cation and payment collection where dominant carriers are
assumed to have market power. These factors also include
rules that require it to open i-mode service to all content
providers and Internet service providers. All these factors
indicate that DoCoMo has to rethink its strategy for global
expansion of i-mode and 3G services.
COMPANY OVERVIEW
In the late 1980s, after much pressure from the Ministry of
International Trade and Industry (MITI) and U.S. govern-
ment, Japan reformed its telecom regulatory structure to allow
the entry of foreign players into Japan’s market. Until then,
Nippon Telegraph and Telephone (NTT) ran a monopoly in
the telecom sector. In order to reduce its monopoly power, in
July 1992, NTT’s mobile communications business was spun-
off to create NTT Mobile Communications Network Inc. The
 Case 11 • NTT DoCoMo: Can i-Mode go Global? • 679

corporate name was officially changed to NTT DoCoMo, Inc. financial condition. In contrast, NTT DoCoMo established
in April 2000. its own shops, a retail operation that was managed jointly
With the entry of foreign players, the competition inten- with trading houses and other companies that exclusively
sified and DoCoMo experienced a drastic decline in sales sold DoCoMo terminals. The incentives for these stores were
from 1992 to 1994. The company felt that there was little dif- significantly lower than those of their competitors.
ferentiation between their products and the ones offered by In February 1999, NTT DoCoMo introduced i-mode, a
other wireless companies in Japan. Also, customer feedback wireless Internet service. In just three years it had 30 million
showed that the growth rate for voice services (1G-first gener- subscribers, (60 percent share of Japan’s mobile Internet mar-
ation technology) was gradually declining. DoCoMo realized ket). Two other rival services EZweb from KDDI and J-Sky
the need to shift to a higher technology in order to differen- from J-phone also did well. EZweb had over 9.3 million users,
tiate itself from its competitors and to sustain growth in the while J-Sky was able to get over 9.7 million subscribers in less
market. As a result of their focused initiatives and the growing than three years.
demand for wireless services in Japan during the mid 1990’s, In October 2001, DoCoMo launched the world’s first third-
DoCoMo emerged as the market leader in 1997. generation (3G) cellular service FOMA in Tokyo. Customers,
Today, NTT DoCoMo is one of the world’s leading wire- though, avoided DoCoMo’s 3G offering because of the high
less communications company with a network covering the price for the service, expensive handsets, and spotty cover-
entire country and more than 45 million customers. The com- age even in key locations like the Tokyo subway. KDDI
pany provides a variety of leading-edge wireless multimedia launched CDMA2002 1x, its 3G service in April 2001 and
services such as i-mode, a mobile Internet service, which gained more than one million subscribers in the first three
provides e-mail and Internet access via high-speed packet months. Although this service was slower than FOMA,
transmissions and FOMA, the world’s first 3G mobile com- KDDI’s upgrade was in sync with the technology standards
munications service based on W-CDMA technology, which worldwide and did not require the rebuilding of a whole sys-
offers visual communication services. tem, as required by FOMA. J-phone followed with its own 3G
DoCoMo has subsidiaries in Europe and North America, service in June 2002. Exhibit 1 shows the current status of 3G
and is expanding its global reach through strategic alliances subscriptions and the overall market competition in Japan.
with mobile and multimedia service providers in Asia-Pacific KDDI/AU has moved almost all its subscribers from 2G to
and Europe. NTT DoCoMo is listed on the Tokyo, London, 3G networks. DoCoMo plans to complete the conversion to
and New York stock exchanges. 3G/FOMA by 2006, while Vodaphone still has a very small
number of 3G subscribers. Both 3G voice and 3G data rates
MOBILE NETWORKS IN JAPAN
are considerably lower than 2G data rates, however the actual
The Japanese mobile market consists of three companies: NTT rates subscribers pay depends on the plan selected, quantity
DoCoMo, KDDI/AU and J-phone (Vodafone). Although of data transferred, contract length, and various discounts.
their market shares in 2003 were roughly 60 percent, 20 per- NTT DoCoMo’s 3G network’s brand name is FOMA and
cent, and 20 percent, respectively, the difference in financial it uses the wCDMA technology standard. Vodaphone also
conditions of NTT DoCoMo and its competitors was even uses the wCDMA standard, while KDDI/AU uses different
larger due to the difference in their strategies for sales and versions of the CDMA 2000-1x standard (CDMA2000-1x and
distribution of handsets in Japan. KDDI and J-phone worked CDMA2000 1xEV-DO) under the brand names: CDMA1x
through independent retailers and paid incentives on top of and CDMA1x-WIN for data download rates up to 2.4 Mbps.
the retail price for the sales of terminals. They focused more The Japanese communication industry has seen enormous
on the market share than on the profit, which weakened their changes. The use of mobile phones has evolved from voice

EXHIBIT 1
3G SUBSCRIPTIONS AND CURRENT COMPETITION IN THE JAPANESE MOBILE SERVICES MARKET

3G mobile subscriptions in Japan

100 million Competition in the Industry
AU/KDDI (cumulative number of subscribers basis)
K.K.
Japan K.K.
www.eurotechnology.com
3G subscription contracts

(CDMA2000-lx) –As of the end of March–

10 million
www.eurotechnology.com
Eurotechnology Japan

Vodafone
FOMA/DoCoMo 18.4%
(c)2004 Eurotechnology

1 million
(wCDMA) TU-KA
4.5%
100,000 DoCoMo
au
56.3%
Vodafone 20.8%
(c)2004

10,000
(wCDMA)

1,000
Jan l, Jan l, Jan l, Jan l, Jan l, Jan l, Source : Telecommunications Carriers Association
2001 2002 2003 2004 2005 2006

Source: www.eurotechnology.com. Source: NTT DocMo, Annual Report 2004.

680 • Case 11 • NTT DoCoMo: Can i-Mode go Global?
communication infrastructure to mobile phone applications
as IT infrastructure. The next likely step is further evolution
of mobile phones as a lifestyle infrastructure.
i-mode, DoCoMo’s Success Story
After its launch in 1999, i-mode became an instant success in
Japan, resulting in a phenomenal growth in DoCoMo’s sub-
scriber base. Company sources mainly attributed the success
of i-mode to its simple and efficient network access, its middle-
ware software, its innovative business model, and its unique
marketing strategies. NTT DoCoMo placed itself between
the users and content by making i-mode a closed and tightly
controlled network. Web pages and e-mails can only reach
an i-mode handset by c-HTML or i-HTML, NTT DoCoMo’s
patented protocols. i-mode users must connect to the Internet
through its gateways. Takeshi Natsuno, executive director of
the i-mode planning division of NTT DoCoMo summed it up:
‘‘The true mechanism of the great success is that the operator
has made a function of coordination of the total value chain.’’
According to analysts, the biggest advantage of i-mode was its
efficient execution of the wireless Internet ecosystem. Refer
to Exhibit 2 for i-mode’s collaboration concept.
DoCoMo had a national network for packet communi-
cations, and through i-mode, its researchers found the best
way to effectively utilize this network. NTT DoCoMo col-
lected monthly information charges on behalf of the i-Menu
content providers—so i-mode users can receive a single, con-
solidated bill for all their mobile phone activities, and the
content providers do not have to worry about billing cus-
tomers directly. This arrangement reduced the expenses and
risks for the content partners, which encouraged them to
EXHIBIT 2
i-MODE ECOSYSTEM
i-mode Collaboration Concept
Inter-Operability Inter-Operability
Platform
Vendors
Business Portal
Opportunity Functionality
Co-marketing Co-marketing
NTT
Handsets DoCoMo
Content
Volume Revenue
Handset Opportunity Collection
Vendors
Content / Handset Integration
This total value chain management is made prossible by a well-balanced
mobile multimedia ecosystem of partners is which the operator plays a
central coordination role.
constantly produce high-quality offerings that would attract
new subscribers and boost their profits. Clever marketing
was another key factor in i-mode’s success. Young Japanese
women determine which trends become successful and long-
lived in Japan, and DoCoMo initially designed its content
with features for young women like shopping sites, ring-tone
downloads, and easy email capability. By making sure that this
group adopted i-mode at an early stage helped DoCoMo to
extend their success in other Japanese user groups. DoCoMo
charged 300 yen for its i-mode service, which most users con-
sidered to be a minor cost. It also consciously chose not to
refer to the term Internet or Web in its promotional campaign
for i-mode during the first year of its launch. i-mode was posi-
tioned as a simple, usable and fun-to-use service, complement
to the voice function. DoCoMo also defined the features of
the phone (handset) it sold and manufacturers did not have
any influence in the retail price or the introduction of new
models.
Was i-mode a Cultural Phenomenon?
Western analysts often point out that the success of i-mode
was a result of several special characteristics and the environ-
ment in Japan: Japan is a pedestrian-centric country and the
penetration rate of PCs in Japan is low, so people have to use a
cell phone instead of a PC for Internet access. However, these
reasons are only partly true. People living in Tokyo mostly
ride trains but those who live outside of Tokyo drive; 50 per-
cent of Japanese households have two cars. Therefore, it’s not
the case that people only use i-mode during their commute.
They use i-mode in their spare time, such as waiting between
meetings. Also, even though PC penetration in Japan is far
Content
Providers
Source: www.nttdocomo.com.
 Case 11 • NTT DoCoMo: Can i-Mode go Global? • 681

lower than in the U.S., Japan is still among the top five nations
in terms of PC usage.
The i-mode phenomenon coincided with changing social
behavior, particularly among Japan’s urban youth. According
to Masahiro Yotsumoto, research director at the Dentsu Insti-
tute for Human studies, ‘‘Young people have a very different
attitude towards personal relationships. Instead of having one
good friend, they prefer to have 200 mobile friends.’’ Another
analyst, Nishioka, points out that sending a short message,
such as saying goodnight to a friend, is one of the most popu-
lar uses of i-mode. The lack of real privacy in small Japanese
houses has also helped to make mobile phones popular. ‘‘In
Japan, especially for young people, their home is their cell
phone,’’ says John Barber, former director of AOL Japan.
BATTLE FOR GLOBAL STANDARDS
In 1982, the Global System of Mobile Communication (GSM)
was established to initiate European Telecommunication stan-
dards. The European government passed a legislation making
it illegal to implement any other system. In contrast, the
absence of a mandated standard by the U.S. government
led to companies adopting different implementations, ranging
from CDMA to two versions of TDMA (GSM and IS-136).
GSM was an improved version of TDMA whereas CDMA
was a completely different technology. The CDMA inter-
face was much superior to GSM or TDMA for data transfer.
In Japan, all 3 Japanese operators deployed second genera-
tion (2G) technologies that were not compatible with GSM
(NTT DoCoMo and Vodafone used PDC whereas KDDI used
CDMAOne). Due to this, Japan was not able to offer GSM
roaming services to those coming from other countries. See
Exhibit 3 for the evolution of mobile telephony.
These 2G choices influenced the early choices of 3G techni-
cal specifications. Exhibit 4 shows the possible migration paths
from 2G to 3G. Although the two approaches CDMA2000 and
wCDMA (Wideband Code Division Multiple Access) were
recommended as a standard technology (for 3G) by IMT-2000
(International Mobile Telecommunications—2000), these
technologies were not perfectly compatible.
KDDI adopted the CDMA2000 standard for 3G, whereas
NTT DoCoMo adopted wCDMA (which it calls FOMA),
which they claim is the first bona fide 3G networks. In Europe,
many telecom companies invested heavily in 3G spectrum
licenses, which can only be used for wCDMA. In the U.S.,
Cingular has decided to use wCDMA for its 3G service,
whereas Verizon is using CDMA2000. This means that users
who need global roaming capabilities will still have to use
multi-technology phones.
INTERNATIONAL EXPANSION
To extend i-mode and 3G services outside Japan, DoCoMo
focused on acquiring stakes in various cellular countries
around the world. Commenting on this, Natsuno Takeshi,
Executive Director of DoCoMo said ‘‘DoCoMo alone is very
sure of the potential of 3G, because we have already experi-
enced the explosive success of the data business. Our overseas
business is to offer our know-how. We cannot give it away
free, but we can make a minority investment in interested

EXHIBIT 3
EVOLUTION OF MOBILE TELEPHONY
Mobile telephony has evolved through various generations: 1G, 2G, 2.5G, and 3G
1G—Analog Communication: The original analog cellular systems introduced in late
1970’s and early 1980’s are considered the first generation of mobile telephony. This was a
voice-based technology that used analog signaling.
2G—Digital Technology: Second generation mobile telephony was also essentially a
voice-based technology but it used digital signaling techniques. Though digital wireless
telephony provided clearer voice transmissions with little disturbance as compared to
analog technology, it was slower due to the circuit switch-on and off. GSM, TDMA and
CDMA were 2G technologies
2.5G—Packet Switching Technology: 2.5G was the interim solution for 2G networks to
have 3G functionality. It used General Packet Radio Service (GPRS), an interim
technology between Global System for Mobile (GSM, 2G) and Universal Mobile
Telecommunication Service (UMTS, 3G) technologies. 2.5G supported transmission of
voice as well as data. It enabled users to access the Internet and send e-mails and large
amounts of data.
3G—Advanced Packet Switching Technology: The third generation of mobile telephony
was designed for high-speed multimedia data with speeds ranging from 128 kbps to
several megabits per second. 3G was also expected to provide advanced global roaming. It
promised to increase the bandwidth and provide faster packet-switched data transfer rate.
DoCoMo was the pioneer of this generation.
4G—Software Defined Wireless Technology: 4G technology is still in the research phase.
It will be able to support interactive sessions like video conferencing, as data would be
transferred at much higher rates. The cost of data transfer would be comparatively less
and global mobility would be possible. The Japanese, Chinese, and South Korean
governments agreed to jointly develop 4G technology and allocate common spectrum for
4G cellular phones which are expected to be available around 2010. Source: Compiled from various
sources
682 • Case 11 • NTT DoCoMo: Can i-Mode go Global?

EXHIBIT 4
POSSIBLE MIGRATION PATHS FROM 2G TO 3G

IS-41 CORE NETWORK

cdm 3 One CDMA2000
IS-95B 1X EV-DO
cdm 3 One
IS-95A CDMA2000 1X
CDMA2000
TDMA 1X EV-DV

EDGE W-CDMA

GSM GPRS

GSM MPA CORE NETWORK

2G 2.5G 3G
Source: ITU Internet Reports 2002, Internet for a
Mobile Generation.

partners. I think it is a perfect strategy.’’ DoCoMo invested in Was it the Right Partnership?
foreign mobile providers who were aiming to deploy the next
It is questionable whether DoCoMo saw its business as a global
generation technology. In May 2000, it bought a 15 percent
business or rather a multi-local business. DoCoMo focused
stake in Dutch KPN mobile to set up Europe’s first i-mode
on acquisitions to expand its business without truly analyzing
service and in December 2000, completed the acquisition of a
the synergy effect from these deals. According to financial
16 percent stake in AT&T for $9.8 billion, planning to estab-
theory, mergers and acquisitions will generate economic gain
lish the first 3G network in the U.S. in 2003–2004. DoCoMo
only if there is a synergy effect or if two firms are worth more
also invested in Hutchison in Hongkong, KG Telecom in Tai-
together than apart. An analyst from Dresdner Kleinwort
wan, and Tele Sudeste in Brazil. In exchange, these carriers
Wasserstein, pointed out that there was no additional gain for
agreed to roll out i-mode and DoCoMo’s version of 3G mobile
DoCoMo by acquiring stake in AT&T Wireless. However,
technology. Through these investments, DoCoMo improved
some analysts also say that DoCoMo was a latecomer in the
its access to Asia as well as the European and American mar-
U.S. market and partnerships with most carriers were fore-
kets. Its network of international investments was intended to
closed to it. DoCoMo selected AT&T wireless largely because
leverage DoCoMo’s know-how from the advanced Japanese
of AT&T’s national footprint and because AT&T agreed to
market. It planned to offer i-mode-type services based on 2.5G
deploy i-mode and implement DoCoMo’s wCDMA standard
to be followed by 3G products and services, which would be
by the end of 2003.
well developed in Japan by that time. DoCoMo was aiming
Furthermore, despite regulatory changes, economics of the
to establish its wCDMA technology as the de-facto world-
mobile industry has remained primarily national in nature and
wide standard for 3G mobile phones. However, its global
it is better to be a market leader in one country rather than a
aspirations soon ended due to the downturn in the global
follower in many countries. In general, a broader geographic
telecommunications market.
scope and higher subscribers than that of other companies
FURTHER PROBLEM’S IN GLOBAL EXPANSION is the true benefit for the leader. Although DoCoMo was
the leader in Japan, this was not true for Europe or North
In fiscal year 2001, DoCoMo was forced to write off almost
America.
1 trillion yen due to the decline in the value of its investments
To be successful in international market by way of merger
in various foreign wireless companies. The gross impairment
and acquisition synergies, DoCoMo should have been more
charges were 664.5 billion yen for AT&T Wireless Service,
serious about gaining management control. Although it accu-
Inc., 320.5 billion yen for KPN Mobile N.V., 36.5 billion yen
mulated direct or indirect shares in nine mobile operators
for KG Telecommunications Co., Ltd., and 56.4 billion yen for
during the telecom bubble period, it was the major player
Hutchison 3G UK Holdings Ltd. In mid 2002, it was reported
only in KPN Mobile in Netherlands and Hutchison in Hong
that DoCoMo was facing problems in convincing its partner
Kong, which were minority geographic markets. The rest
wireless companies to adopt its technology. These companies
of the investments were not successful for being a mar-
were reluctant to spend huge amounts upgrading their net-
ket leader. AT&T Wireless was the No. 3 player in the
works, as they feared DoCoMo’s products and services might
U.S., KG Telecom was No. 4 in Taiwan, and Hutchison
not attract customers in their countries. They had already
was No. 5 in U.K. Since DoCoMo was the minority share-
spent billions of dollars in acquiring 3G licenses and did not
holder, it had very little or no management control. DoCoMo
have the financing to set up and operate 3G networks. As a
argued that the objective of global business expansion was
result, a number of leading telecom companies in Europe and
to generate royalties from its i-mode business model for
the U.S. decided to delay their 3G roll out plans, which were
mobile Internet services in joint ventures with newly acquired
initially projected for 2002 and early 2003.

partners and to increase the adoption of DoCoMo’s 3G
mobile technology standard. In Japan, DoCoMo was able
to dominate the entire value chain by specifying standards
for handset manufacturers and regulating the content from
content providers. Did it evaluate all the success factors for
its i-mode service in Japan before expanding to overseas
markets?
Was the U.S. Ready for i-mode?
At the time of the acquisition of AT&T, Japan and Europe
had already begun migrating to the 3G networks whereas in
the U.S. there were many full second-generation network cov-
erages and some 2.5G providers. Although the limited 2.5G
data transmission speed did not support advanced multimedia
services, it provided the basic content that satisfied customers.
This was, however, not sufficient to be marketed as i-mode
under DoCoMo’s standards.
The preferred protocol for mobile information services in
the U.S. was wireless application protocol (WAP), which
allowed users to connect to the Internet and advanced
telephony services. It required the use of wireless markup
language (WML) to create content (Internet sites). WAP is
an open standard, not controlled by a single vendor. But
its widespread adoption was uncertain due to its technical
limitations. In contrast, DoCoMo used its own protocol for
i-mode in combination with its proprietary c-HTML language.
Switching to i-mode would thus be more expensive.
Although most carriers had introduced mobile Inter-
net access based on the WAP protocol, similar capabilities
were also offered by providers of mobile e-mail services,
such as Blackberry, and of wireless personal digital assis-
tants (PDA’s). The distinction between cellular phones and
PDA’s were beginning to blur as new cellular handsets incor-
porated PDA functionality and wireless PDA’s were voice
enabled.
Furthermore, the U.S. market was different from the
Japanese market in terms of fragmentation and a widely
dispersed population. The intense competition in the U.S.
market had led to flat rate calling plans, so there was little
incentive for mobile carriers to increase network usage. In
addition, U.S. prices were often set too high to encourage
frequent use of additional services.
What Happened in the UK?
Although DoCoMo’s technology was far superior to WAP,
which European operators had been successfully marketing
to their customers, very few users signed up for i-mode.
Mobile Internet services were not as popular in Europe as
they were in Asia and after studying the UK market, 3UK
decided against deploying i-mode. The local operators in
Europe were also facing problems in launching i-mode com-
patible technology in place of the standard WAP technology.
In May 2004, DoCoMo announced that it had terminated
its investment in Hutchison 3G UK holdings, which oper-
ates 3UK. Some other reasons that contributed to the failure
were the launching of i-mode service during a recession, poor
quality of i-mode enabled handsets, and the opportunity for
WAP to bounce back. Many consumers considered i-mode
as an interim technology that would soon be superseded
by 3G. As John Tysoe, mobile-industry analyst at WestLB
Panmure in London pointed out, ‘‘It will be tough to persuade
Case 11 • NTT DoCoMo: Can i-Mode go Global? • 683
people to get an i-mode handset when so much has been said
about 3G.’’
Investors wanted DoCoMo to rethink its overseas adven-
tures.
FINANCIAL HIGHLIGHTS: DoCoMo
Overall Operating Result
In fiscal year 2003, total operating revenue of the company
increased by 4.97 percent to 5,048 billion yen while operat-
ing income increased by 4.36 percent. Net income increased
from 212.49 billion yen in FY2002 to 650.01 billion yen in
FY2003, representing a 206 percent increase. This surge in
net income was attributable to the reduction in write-downs
of investment in affiliates and equity in net losses of affiliates,
and the gain from sales of AT&T securities. The percentage of
operating expenses to sales reduced slightly from 78.5 percent
in FY2002 to 78 percent in FY2003 as a result of a decrease
in sales commissions. In FY2003, the cost of providing ser-
vices increased by 0.8 percent YOY. However, cost/revenue
percentage decreased from 16.32 percent to 15.97 percent in
FY2003 as a result of economies of scale from the increase in
cellular traffic volume. DoCoMo reported an operating loss
in FY2001 of 116 billion yen despite an increase in operat-
ing revenue from FY2000. This was attributable to the loss
in equity of affiliates, which reflected the poor performance
of international investments. AT&T reported operating loss
and impairment of goodwill totaling 664.5 billion yen. At the
same time, there were impairment charges of 320.5 billion yen
to the investment in KPN Mobile N.V., 36.5 billion yen for
KG Telecommunications Co., Ltd, and 56.4 billion yen for
Hutchison 3G UK holdings Ltd.
Financial Position
In FY2003, the company’s assets increased by 3.67 percent
to 6,262 million yen. DoCoMo has invested more in wireless
telecommunication expenses, building a structure to support
the increase in subscribers, R&D for fourth generation (4G)
services and for servers for Internet-related services, and 3G
FOMA infrastructure. While cash for business expansion is
still needed, DoCoMo depended less on debt. Debt to asset
ratio decreased gradually every year from 45.74 percent in
FY2001 to 40.84 percent in FY2003. Decrease in the depen-
dence on debt will enable DoCoMo to sustain its business
growth in the long run.
Return on Equity
DoCoMo’s ROE increased from 6.11 percent in FY2002 to
17.84 percent in FY2003 because of the increase in net profit
margin and higher asset turnover ratio (to measure how the
company efficiently generates sales from its asset). As stated
above, the increase in net profit margin in FY2003 came
from the reduction in loss and impairment of investments
in affiliates. Operating margin, which represented the per-
formance of its main business, however, decrease from 22.0
percent to 21.8 percent. Asset turnover increased slightly from
0.79 times to 0.82 times in FY2003. In sum, the increase in
ROE did not result from increase in profit margin of its main
business but from the decrease in the loss of investment in
affiliates and higher efficiency in generating sales from its
assets.
684 • Case 11 • NTT DoCoMo: Can i-Mode go Global?

EXHIBIT 5
FINANCIAL HIGHLIGHTS
Million of Yen Million of US dolars
2000 2001 2002 2003 2004 2004 ROCE
Operating results
Operating Revenues 3,718,694 4,686,004 4,659,254 4,809,088 5,048,065 48,456 23.50%
23.00%
Wireless services 2,978,881 3,590,134 4,153,459 4,350,861 4,487,912 43,079 22.50%
Equipment sales 739,813 1,095,870 505,795 458,227 560,153 5,377 22.00%
21.50%
Operating Income 509,178 778,620 1,000,887 1,056,719 1,102,918 10,587 21.00%
Net Income (loss) 256,564 401,755 (116,191) 212,491 650,007 6,239 20.50%
20.00%
19.50%
19.00%
Basic Data per Share 18.50%
Basic and diluted earnings (loss) 26,792 8,350 (2,315) 4,254 13,099 125.73 18.00%
Dividends decared and paid 200 200 1,000 9.60 2000 2001 2002 2003 2004

Financial Position
Total Assets 3,613,124 6,016,505 6,067,225 6,058,007 6,262,266 60,110
Total debt 1,636,966 2,697,918 2,775,342 2,582,493 2,557,571 24,549 Net Income (Loss) and ROE
Total shareholders' equity 1,976,158 3,318,587 3,291,883 3,475,514 3,704,695 35,561
800,000 20.00%
Cash Flows 2000 2001 2002 2003 2004 600,000 15.00%

Mil lio n Yen

Cash flows from operating activities 1,048,188 839,312 1,341,088 1,584,610 1,710,243 16,416 400,000 10.00%
Cash flows from investing activities 999,264 2,744,215 1,125,093 871,430 847,309 8,133
200,000 5.00%
Free cash flow 85,929 (1,936,713) 215,995 713,180 862,934 8,283
- 0.00%
Other Financial Data (200,000) 2000 2001 200 2 2003 2004 -5.00%
EBITDA 999,579 1,158,029 1,680,596 1,836,264 1,858,920 17,843 Net Income (loss)
Capital expenditures 876,058 1,443,168 1,032,256 853,956 805,482 7,732 ROE

Financial Ratios 2000 2001 2002 2003 2004

Operating margin 14.70% 16.60% 21.50% 22.00% 21.80% Operating Revenue s an d Income be for e
EBITDA margin 31.10% 30.50% 36.10% 38.20% 36.80% Inco me Taxes
6,000,000
ROE 13.51% 15.13% -3.54% 6.11% 17.84%

Million Yen
5,000,000
ROCE 19.80% 20.70% 21.10% 22.10% 22.90% 4,000,000
Asset turnover 1.071 0.973 0.771 0.793 0.819 3,000,000
Net profit margin 6.90% 8.57% -2.49% 4.42% 12.88% 2,000,000
1,000,000
Equity ratio 54.69% 55.16% 54.26% 57.37% 59.16% -
Asset/Equity ratio 1.83 1.81 1.84 174
. 1.69 (1,000,000) 2000 2001 2002 2003 2004
Debt ratio 45.31% 44.84% 45.74% 42.63% 40.84% Operating Revenues Operating Income Net Income (loss)

EBITDA & EBITDA margin Cash flow

Debt ratio
47.00% 2,000,000 50.00%
46.00% 2,000,000
45.00% 1,500,000 40.00% 1,000,000
44.00%
Yen

30.00% -
Yen

43.00%
Yen

1,000,000 2000 2001 2002 2003 2004

42.00% 20.00% (1,000,000)
41.00% 500,000 (2,000,000)
40.00% 10.00%
39.00% - 0.00% (3,000,000)
38.00% Cash flows fromoperating activities
20002001200220032004
2000 2001 2002 2003 2004 EBITDA Free cash flow
EBITDA margin Capital expenditures

Source: www.nttdocomo.com

Source: www.nttdocomo.com.

CURRENT EXPANSION STRATEGIES O2 will launch services based on i-mode technology but under
its own brand.
Expansion Strategy in U.S
Expansion Strategy in Japan
DoCoMo and Cingular Wireless are negotiating to introduce
i-mode and 3G services to Cingular’s customers in the U.S. In April 2005, DoCoMo acquired a 34 percent stake in Sum-
They aim to reach an accord in 2005. DoCoMo also announced itomo Mitsui Financial Group’s credit card unit to enter
that it will soon set up a $100 million venture fund in the U.S. into credit card business aiming to diversify its business,
to invest in start-up companies that develop advanced mobile as core mobile communications business is gloomy with a
communication technologies. After the company failed in its saturated market. Moreover, this integration of telephone
overseas investments, it decided that smaller investments in and credit card will enable subscribers to settle payments
promising venture companies would be a better option. Invest- through their mobile handsets. According to president Naka-
ment in stakes of U.S. ventures will also shorten DoCoMo’s mura, ‘‘DoCoMo could no longer hope to expand revenue
own development cycle, lower R&D costs, and widen its by depending on growth in subscribers and traffic usage.’’ He
opportunities. expected a 25 percent drop in operating profits and 4.5 percent
decline in revenue this year. DoCoMo plans to reduce costs
Expansion Strategy in the UK to deal with the expected decline in revenue, particularly in
In November 2004, DoCoMo signed an agreement with mm02 distributor subsidies. Recently DoCoMo announced that it
plc under which the European mobile operator will provide will stop rolling out 2G handsets and focus on expanding its
i-mode services to its 22 million customers in the UK, Ger- 3G handset lineup further by adding new models. DoCoMo is
many, and Ireland. O2 U.K and O2 Ireland will exclusively use facing tough competition in the 3G services market in Japan
i-mode brand and technology in their markets. In Germany, as only 25 percent of its overall customers have subscribed

to FOMA. In contrast, KDDI, its nearest rival provides 3G
services to 92 percent of its customers.
DoCoMo’s i-mode Clone Grows Quietly in France
Meanwhile, France’s Bouygues Telecom successfully dupli-
cated DoCoMo’s development and marketing strategies. It
seems that the availability of better handsets like those in
Japan, a well-defined and controlled portal strategy, and a
marketing focus that led to i-mode’s success in Japan, if
properly cloned, could be successful. Bouygues achieved a
milestone of 500,000 customers within 12 months of launching
the i-mode service in France. As of April 2005, it had 1.1
million i-mode subscribers.
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 12
THE FUTURE OF NOKIA
Jorma Ollila sat at his desk looking out over the skyline of
Keilalahti in Espoo, Finland. As Chief Executive Officer, he
held a fond sense of security when he was here at the global
headquarters of Nokia, Inc. But recently, that feeling had
slowly begun to change, as more and more of Jorma’s time
was focused on developing elements of Nokia’s global plan.
For years, that plan had been simple—utilize company facil-
ities to manufacture large quantities of Nokia phones that
were known for their style and quality. But suddenly, things
weren’t so simple anymore. Competitors had begun using
low-cost manufacturers and the tastes of the global cell phone
market both shifted and split. From a design and function per-
spective, global consumption had increasingly moved towards
the new ‘‘clamshell’’ design and converging features, while at
the same time, clear purchase distinctions could now be made
between new and existing markets.
It was obvious that Nokia’s business model is in need of
an overhaul. What is not clear to Jorma is just how much of
an overhaul would be needed and how he would go about
accomplishing it.
HISTORY OF NOKIA
Nokia’s history can be traced back to 1865, with the founding
of a forest industry enterprise in southwestern Finland. Engi-
neer Fredrik Idestam established a mill to manufacture pulp
and paper on the Nokia River. A little more than a century
after Nokia was founded, in 1967, Nokia merged with Finnish
Rubber Works (established in 1898) and Finnish Cable Works
(established in 1912) to the form what is now known as the
Nokia Corporation.
Nokia made several acquisitions in the 1980s to increase
its position in the telecommunications and consumer elec-
tronics markets. Among other companies, Nokia acquired
Scandinavia’s largest maker of color televisions, Salora, and
This case was prepared by Katja Fischer, Charlie Huynh, Marisa Kos-
sakowski, and Thomas R. Schuler of the Fox School of Business and
Management at Temple University under the supervision of Professor
Masaaki Kotabe for class discussion rather than to illustrate either effective
or ineffective management of a situation described (2004).
Case 12 • The Future of Nokia • 685
DISCUSSION QUESTIONS
1. What were the major factors that led to the success of
i-mode in Japan?
2. Do you support DoCoMo’s global strategies in 2001?
Why/Why not?
3. Why are there signs of success in the Europe?
4. Given the current scenario, do you think DoCoMo should
focus on Asia or continue with its global expansion in U.S.
and Europe?
5. DoCoMo is diversifying into credit card business. How
effective do you think is this strategy?
the Swedish electronics and computer company, Luxor, in
1984. Four years later, Nokia bought the data systems division
of Sweden’s Ericsson, which made it the largest information
technology company in Scandinavia. This was the first step in
becoming a major player in the European market for infor-
mation technology. Over time, Nokia has expanded into tires,
power transmissions, radio, telecom, electronics and computer
technology.
In 1998, Nokia bought a number of small companies that
develop e-commerce and telephony technologies to expand
its drive into mobile Internet capability. Nokia also made
several acquisitions to reinforce its Internet protocol network
business. In 2001, Nokia added Internet security appliances
to its product line-up with the acquisition of Ramp Net-
works.
NOKIA’S MOVE TO MOBILITY
Kari Kairamo, who became CEO in 1977, saw Nokia’s future
in technology, even though he came from the forestry side
of the business. Under him, the company launched its first
mobile phones in the 1980s and introduced its first NMT
portable phone in 1987. (NMT was the network that preceded
GSM.) The current CEO of Nokia, Jorma Ollila, took over the
mobile phone business in 1990, and in 1992, Nokia introduced
its first GSM hand-portable phone. In 1994, he decided to
focus on mobile phones and telecommunications as the core
of the business and divested its non-core operations.
Mobile phones at that time were considered very expensive
business tools. However, Ollila predicted that as they became
cheaper and lighter, they might become a must-have item
among consumers. In 1996, Nokia introduced the world’s first
all-in-one communications device, the Nokia 9000 Commu-
nicator. Since 1997, Nokia has been focusing on the mobile
Internet as it moves towards a ‘‘mobile information society.’’
In 2001, Nokia began working with other phone makers and
service providers to develop a global standard for 3G soft-
ware, so named because it is the third generation of mobile
technology. In 2002, Nokia announced its first phone with a
built-in camera.
686 • Case 12 • The Future of Nokia

According to sales figures of 2003, Mobile Phones gener-
ated 80 percent of Nokia’s net sales, networks 19 percent, and
ventures 1 percent of net sales. (See Exhibit 1.) It is obvious
that Nokia’s primary business is mobile phones.
NOKIA’S MOBILE PERFORMANCE
Nokia sold over 40 million mobile phones in 1998, surpassing
Motorola and making it the world’s number one mobile phone
company. The fast growth of the mobile industry in terms of
the speed of mobile phone sales astonished even Nokia. In
1992, the company predicted that no more than 50 million
handsets would be sold worldwide in 1999. The actual figure
was more than 250 million. The exceptional growth in demand
for mobile phone technology meant that from 1995 to 1999,
sales figures tripled, profits rose by nearly three times and
the share prices rose rapidly. From 1996 to 2000, worldwide
sales of mobile handsets grew by an unbelievable 60 percent
annually, but the year 2000 was a turning point as the market
matured.
Currently, Nokia is struggling to sustain its lead in the
global handset market. When the company was poised to
reach its goal of 40 percent market share, major competi-
tors such as Motorola began to fight back. (See Exhibit 2.)
Nokia’s net sales for Q2 2004 were $8.1 billion, a decrease of
5 percent compared to the same quarter in 2003. Operating
profit for the company was $1.1 billion, with operating margin
at 13.7 percent, up from 11.7 percent in the 2nd quarter of
2003. According to the second quarter results of 2004, both
Nokia’s unit sales and margins have come under attack. Much
of Nokia’s own growth in Q2 appeared in Brazil, India, and
Russia instead of its customary, wealthier European market.
For the 2nd quarter 2004, Nokia’s European handset market
made up 44 percent of total sales, with the Asian market
accounting for 28 percent.
ORGANIZATIONAL SETUP
Nokia has been called possibly the least hierarchical large
company in the world. One of Jorma Ollila’s goals is for
Nokia to seem like a small, intimate organization despite the
fact that it has more than 50,000 employees spread around
the world. To better position itself for the future, Nokia
reorganized itself into four primary business groups at the
beginning of 2004. These include Mobile Phones, Multime-
dia, Networks and Enterprise solutions. Its focus remains on
mobile phones and networks. The new structure also includes
three horizontal groups: Customer and Market Operations,
Technology Platforms and Research, and Venturing and Busi-
ness Infrastructure. (See Exhibit 3.) Responsibilities for these
groups are global; Nokia does not further segment at this level
by region.
The control and management of Nokia is divided among
the shareholders, the Board of Directors and the Group Exec-
utive Board. In addition to being CEO, Jorma Ollila is also
Chairman of the Board. Paul J. Collins is the Vice Chairman.
There are eight members of the Board of Directors; all of the
current members were re-elected from last year. Members of
the Board of Directors take an active role in the company, and
are responsible for regularly evaluating the strategic direction
of the company.
THE NOKIA WAY
Simply stated, the mission of Nokia is ‘‘Connecting People’’
and the company does this through a program called ‘‘The
Nokia Way.’’ In achieving this, its strategy focuses on three
activities used to expand mobile communication in terms of
volume and value. They include:
1.) Expand mobile voice.
2.) Drive consumer multimedia.
3.) Bring extended mobility to enterprises.
The Nokia Way brings together talented individuals who
share the right values. Customer satisfaction, respect, achieve-
ment, and renewal are the values that make up the Nokia
Way. The overall organizational setup of Nokia is flat and
network-organized, and Nokia believes that the speed and
flexibility it achieves in decision-making is a product of the
Nokia Way.
Nokia has a strong system for internal communications;
they measure internal communication performance through
the annual employee opinion survey. Nokia uses Nokia People
Magazine as a channel for communicating with its employees,
as well as Nokia News Service, the daily online news service
for employees worldwide.
For its consumers, Nokia has created Club Nokia, a club
that offers a direct help line for Nokia phone owners, invites
to all Nokia events and a Nokia newsletter. The only prerequi-
sites are that you own a Nokia cell phone. The club gives users
exclusive benefits and priority customer support. Currently
available in 33 countries, Club Nokia is a good way for Nokia

EXHIBIT 1
NOKIA 2003 SALES BY BUSINESS GROUP

Net sales by business 1%

group 2003 19%

Nokia Mobile Phones

Nokia Networks
80%
Nokia Ventures Organization
Source: Retrieved from:
http://www.nokia.com/nokia/0,8764,64355,00.html.
 Case 12 • The Future of Nokia • 687

NOKIA 1999-2003, IAS

2003 2002 2001 2000 1999

Profit and loss account, EURm
Net sales 29 455 30 016 31 191 30 376 19 772
Cost and expenses −24 444 −25 236 −27 829 −24 600 −15 864
Operating profit 5 011 4 780 3 362 5 776 3 908
Share of results of associated companies −18 −19 −12 −16 −5
Financial income and expenses 352 156 125 102 −58
Profit before tax and minority interests 5 345 4 917 3 475 5 862 3 845
Tax −1 699 −1 484 −1 192 −1 784 −1 189
Minority interests −54 −52 −83 −140 −79
Net profit 3 592 3 381 2 200 3 938 2 577

Balance sheet items, EURm

Fixed assets and other non-current assets 3 837 5 742 6 912 6 388 3 487
Current assets 20 083 17 585 15 515 13 502 10 792
Inventories 1 169 1 277 1 788 2 263 1 772
Accounts receivable and prepaid expenses 6 802 6 957 7 602 7 506 4 861
Available-for-sale investments 816 - - - -
Cash and cash equivalents 11 296 9 351 6 125 4 183 4 159
Shareholders' equity 15 148 14 281 12 205 10 808 7 378
Minority shareholders' interests 164 173 196 177 122
Long-term liabilities 328 461 460 311 407
Long-term interest-bearing liabilities 20 187 207 173 269
Deferred tax liabilities 241 207 177 69 80
Other long-term liabilities 67 67 76 69 58
Current liabilities 8 280 8 412 9 566 8 594 6 372
Short-term borrowings 387 377 831 1 069 792
Current portion of long-term loans 84 - - 47 1
Accounts payable 2 919 2 954 3 074 2 814 2 202
Accrued expenses and provisions 4 890 5 081 5 661 4 664 3 377

Total assets 23 920 23 327 22 427 19 890 14 279

EXHIBIT 2
GLOBAL MARKET SHARE —MOBILE HANDSET MANUFACTURERS
2000 2001 2002 2003 Q2 2004

Nokia Nokia Nokia Nokia Nokia

30.6% 35.0% 35.8% 34.7% 28.9%
Motorola Motorola Motorola Motorola Motorola
14.6% 14.8% 15.3% 14.5% 15.4%
Ericsson Siemens Samsung Samsung Samsung
10.0% 7.4% 9.8% 10.5% 14.5%
Siemens Samsung Siemens Siemens Siemens Source: Carter, B. (2004), ‘‘Handset
Hostilities,’’ Marketing (UK),
6.5% 7.1% 8.2% 8.4% 6.6% September 29, 2004, pp. 32–33; and
Panasonic Sony Ericsson Sony Ericsson Sony Ericsson Sony Ericsson Cuddeford Jones, M. (2004), ‘‘A
5.2% 6.7% 5.5% 5.1% 6.6% Mobile Design for Life,’’ Brand
Strategy, September 2004, p. 22.
688 • Case 12 • The Future of Nokia

EXHIBIT 3
NOKIA’S REVAMPED ORGANIZATIONAL STRUCTURE
Nokia Business Group Structure

Customer and
Market Operations

Technology Mobile Enterprise

Platforms Multimedia Networks
Phones Solutions

Research,
Venturing, Business
Infrastructure and
Operating Resource
Source: Retrieved from: Sourcing
http://www.nokia.com/nokia/0,8764,33080,00.html.

GLOBAL MOBILE PHONE MARKET VOLUME

(SHIPMENTS MILLION, 1998–2002)

Shipments million Growth

450 60
400
50
Shipments million

350
300 40
% Growth

250
30
200
150 20
100
10
50
0 0
1998 1999 2000 2001 2002
Year Source: Datamonitor, November 2003 Global Mobile Phone Industry
Profile.

Nokia Net Sales by Major Markets (EURm)

2003 2002 2001

USA 4,475 4,665 5,614

UK 2,693 3,111 2,808
Germany 2,297 1,849 2,003
China 2,013 2,802 3,418
UAE 1,886 925 619
India 1,062 538 264
Italy 1,003 1,342 1,168
France 867 1,273 1,260
Brazil 805 773 892
Spain 748 531 644 Source: http://www.nokia.com/nokia/0,8764,64354,00.html.

to put out a positive social image as being concerned with
good customer service and connecting people.
NOKIA AND THE ENVIRONMENT
Nokia is currently working on a few environmentally-friendly
programs; Nokia and the EC are building a market for
‘‘greener’’ products. One program is the Integrated Product
Policy (IPP). The IPP is an environmental initiative to consider
the performance of products and services across their life cycle.
Nokia’s environmental vision shows how Nokia sees mobile
technology as an enabler that can help create a more sustain-
able world. Nokia’s strategy for sustainable environmental
development is implemented through four key programs:
Design for Environment, Supplier Network Management,

Environmental Management Systems and Sound End-of-Life
Practices.
COMPETITION
The competitive set of Nokia is at the same time vastly differ-
ent and incredibly similar. By nationality, the industry is quite
diverse with global players from the United States, Korea,
Germany, Japan, and Europe. While in the past, technolo-
gies, designs and features separated one from the other, those
dividing lines are quickly becoming blurred.
The industry is characterized by a tremendous amount of
SKUs for each manufacturer. There is much pressure from
consumers for each manufacturer to offer the latest in tech-
nology and features, such as color screens, camera phones,
customizable ring tones, clamshell phones, etc. This results in
a homogenized sea of cell phone handsets that can be quite
confusing in aggregate, as they are differentiated only by slight
design tweaks. Distribution is typically tied to carriers of wire-
less service, and this also helps drive market share at the end
of the day.
Local players are becoming more of a factor as newer tech-
nologies are licensed out for the purpose of cost savings, but at
this point, they remain scattered and have limited impact. Data
and background information on such local manufacturers is
extremely limited at this point.
Research in the popular press gives the impression that
consumers’ preferences globally are for the most part simi-
lar. Manufacturers hedge against differing tastes by having so
many cell phone handset SKUs in their arsenal. The main play-
ers carry a full range of options to cover most any consumer’s
needs. The result is the dominance of the global market by
firms such as Nokia, Motorola, Samsung, Siemens and Sony
Ericsson. This is seen clearly as they have accounted for 70
percent or more of the global market for mobile handsets
share since 2001.
EXHIBIT 4
MOTOROLA 2003 SALES
BY PRODUCT SEGMENT
Segment 2003 Sales
Personal Communications 38%
Semiconductor 17%
Global Telecom Solutions 15%
Comm., Govt., Industrial 14%
Integrated Electronics 8%
Broadband 6%
Other 2%
Motorola
For over 75 years, Motorola has been a leader in electronic
products and wireless, broadband and automotive technolo-
gies. 2003 sales were $27.1 billion, which was slightly down (0.9
percent) from 2002. Currently, 38 percent of its sales come
from the personal communications segment. (See Exhibit 4.)
While its main market focus is the United States, it maintains
a presence in the European, Chinese, Asia-Pacific and Latin
America regions. (See Exhibit 5.) From a design standpoint,
Motorola has led the way with its clamshell style cellular
Case 12 • The Future of Nokia • 689
phones. They have been particularly popular in the U.S. and
Asian markets. Motorola continues to upgrade their prod-
ucts, focusing now on third generation (3G) technology and
push-to-talk capability. In China, Motorola benefits from an
agreement with one of the country’s largest mobile operators,
China Mobile Communications Corporation.
Samsung
Samsung’s product offerings range from cell phone handsets
to televisions, computers and home appliances. 2003 sales for
Samsung were $36.4 billion, up 9 percent from 2002. Informa-
tion provided by Samsung as to sales breakdown by market
and region is extremely limited. However, global market share
trends show that Samsung is making quite an impact in recent
years. (See Exhibit 2.) Samsung phones are following industry
trends toward improved features and technology. Samsung is
also strong on the manufacturing side as it is one of the largest
producers of chips for mobile phones. It recently partnered
with Napster to offer a portable music device and possibly
expand the scope of its mobile phones.
Siemens AG
Siemens AG has traditionally been an electronic and indus-
trial company, with a focus on electrical engineering. It is
Europe’s second largest mobile phone manufacturer behind
Nokia. The company recently demonstrated its engineering
prowess through the introduction of its new SX1 device (in
partnership with O2). This is the first handset to have the
ability of downloading fully protected music over the air with-
out the need of a separate player (i.e. one does not need to
download music onto a computer and then transfer it to the
cell phone). Fiscal year 2004 sales were $106,655 billion, up
7 percent from fiscal year 2003. Corporate sales are spread
fairly evenly throughout the world. (See Exhibit 6.)
EXHIBIT 5
MOTOROLA 2003 SALES
BY REGION
Region 2003 Sales
United States 50%
Europe 14%
China 10%
Asia-Pacific 10%
Latin America 8%
Japan 3%
Other 5%
Sony Ericsson
Formed in 2001 through a strategic alliance between Sony
Corporation and Ericsson, Sony Ericsson Mobile Commu-
nications offers technologically advanced mobile multimedia
products. This merger pushed Sony Ericsson immediately into
the top 5 global mobile phone manufacturers. (See Exhibit 2.)
This alliance leverages the innovative operations of both firms
to produce handsets and offer services. For example, the S700
(digital camera phone) is shaped like a jack knife (or swivel
style) and thus resembles a digital camera with a lens on the
front and display screen on the back. This design was a direct
690 • Case 12 • The Future of Nokia
EXHIBIT 6
SIEMENS AG 2004 SALES
BY REGION
Region 2004 Sales
Europe (excl. Germany) 34%
Germany 23%
The Americas 23%
Asia-Pacific 12%
Other 8%
influence of Sony’s swivel-style digital cameras and Ericsson’s
popular clamshell phone styles. The display screen can be
flipped open to reveal the cell phone number pad. Financial
breakdowns regarding markets and products are unavailable
from Sony Ericsson.
Nokia should be aware, however, of several Japanese man-
ufacturers that are also starting to gain some momentum,
particularly in the European market. They include NEC,
Sharp, and Panasonic. Other manufacturers, such as Alcatel,
of Paris, Huawei, and ZTE, both of China, are targeting newer
developing markets with low-cost offerings, in efforts to gain
a foothold in these markets of great potential.
NOKIA’S EXPANSION BEYOND EUROPE
Even though Nokia’s history is long, its expansion outside of
Finland and the rest of Europe has only happened recently.
Jorma Ollila said in 1997, ‘‘Until the 1980s, Nokia was a Finnish
Company, in the 1980s Nokia was a Nordic company, and in
the beginning of the 1990s a European company. Now, we
are a global company.’’ After being appointed CEO in 1992,
Jorma Ollila set about focusing Nokia ruthlessly on the mobile
business, but he also focused on turning it into a global com-
pany as well. Nokia seems to have taken globalization in stride.
According to CFO Olli-Pekka Kallasvuo of Nokia, ‘‘We were
really the first company in the world to go non-domestic and we
remain the ultimate case study. We had to mentally grow out
of Finland pretty early on. Our roots, history and traditions lie
here, but our shares are held in the new markets of the U.S.’’
Since 1994, when Nokia was listed on the New York Stock
Exchange, America has become Nokia’s most important geo-
graphic region in terms of both shareholders and sales. By the
mid-90s, the position of the Finnish home base was decreasing
while the significance of the overseas markets grew. However,
EXHIBIT 7
NOKIA 2003 SALES BY MARKET REGION
Net sales by market area
2003
Europe / Africa / Middle East
Asia-Pacific
Americas
Source: Retrieved from:
http://www.nokia.com/nokia/0,8764,64355,00.html.
Nokia was not really noticed in the Unites States prior to the
late 1990s.
In 1994, Nokia was the first European manufacturer to
begin selling mobile phones in Japan. By learning from the
Japanese and U.S. markets, Nokia was able to create better
phones. Although Nokia first arrived in the Chinese market
around 1985, their real growth there did not begin until the
late 1990s as well.
NOKIA’S APPROACH TO DIFFERENT MARKETS
Nokia has been aiming to do whatever it takes to integrate
itself with consumers, customizing its marketing to meet
regional preferences. Nokia’s marketing approach has cen-
tered on its ability to maintain its central brand elements
while still adjusting the execution of its message to match
local tastes. In 2002, the company introduced the Nokia 3610
to the Chinese speaking market, with enhanced Chinese fea-
tures such as a lunar calendar with Chinese festival days
and improved Chinese phonebook sorting. Additionally, this
phone is claimed to be the world’s first phone to support Hindi
input, which makes it an appealing choice for consumers in
India, as well.
Nokia strongly encourages a global mindset. English is
its official language and it expects senior managers to work
abroad. Also, more than half of the research and development
is done outside of Finland. Nokia has research and devel-
opment centers in fifteen countries. Nokia sells its products
in more than 130 countries and has manufacturing plants in
10 countries. Nokia has recently stated that it will open a
new manufacturing plant in India. This is a part of Nokia’s
attempt to meet increasing demand for mobile devices in India.
Europe/Africa/Middle East made up 57 percent of Nokia’s net
sales, the Americas 21 percent, and Asia-Pacific 22 percent in
2003. (See Exhibit 7.)
By the year 2000, different areas of the world had come
to mean different things for Nokia. Finland was largely a
test market for the company, while the United States repre-
sented an environment of price competition. Japan became for
Nokia an area of experimentation with cutting-edge products,
while China, because of low penetration, represented an area
with enormous growth potential. In order to speed Nokia’s
international growth, CEO Ollila has engaged Nokia’s man-
agers worldwide in strategy development and has instructed
them to act locally in foreign markets and to develop a deep
understanding of local cultures.
21%
57%
22%

In 2003, Nokia outsourced 25 percent of its handset
business. In the future, according to CEO Jorma Ollila, out-
sourcing is an area where the company may consider trying
to save as much as possible. Nokia already has several joint
ventures in China, which provides substantially lower costs
of manufacturing than in Europe and the U.S. China has
emerged as a strategic market and important manufacturing
base for Nokia.
KEY ISSUES
Nokia has long dominated the global cellular phone market.
For the past four years, its global market share has been
more than double that of its nearest competitor. However,
early indications in 2004 signaled that this trend was not to
continue. While handset sales were up, overall market share
had decreased several points to the advantage of Motorola
and Samsung. From a ‘‘big picture’’ standpoint, it appeared as
though Nokia’s reluctance to embrace clamshell style phone
designs had finally caught up with them. Competitors such as
Motorola, Samsung, and Siemens have featured them in their
lines for several years now, and it is paying dividends for them.
To understand the true complexity of this issue, one needs
to look at Nokia’s existing business model for cell phone pro-
duction as it relates to modern day demand. It is also worth
dividing the global cell phone market into two subsections,
developed markets and developing markets, to better see how
Nokia’s approach matches up with the consumer needs of
each. While consumer tastes vary somewhat from country to
country, major cell phone brands handle this through their
extensive lineup of SKUs. The issue has become more or less
one of grouping countries by purchase behavior so as to best
realize economies of scale in production.
NOKIA’S CURRENT BUSINESS MODEL
Because of its position as market leader over the past decade,
Nokia has been able to manufacture and sell cell phones quite
profitably. They realize economies of scale in production by
manufacturing a standardized product lineup in large volumes.
Production takes place in corporate-owned factories located
around the world. Up until this point, this has been a com-
petitive advantage for Nokia that competitors were unable to
imitate. For example, compare Nokia’s operating margin on
mobile phones of 23 percent in 2003 to Motorola’s, which was
just under 5 percent.
Times have changed, however, and in recent years cell
phone technology has been licensed by other competitors to
lower-cost manufacturers, many of them in China. Even as
the number of cell phone users has risen and handset sales
have increased, the average retail price of the equipment has
actually gone down. Cell phones have become a commodity
to a certain extent, and this should continue.
EXHIBIT 8
NOKIA R&D EXPENSES
(US$ MM) 2001 2002 2003
Net Sales $ 41,481 $ 39,918 $ 39,172
R&D $ 3,970 $ 4,059 $ 5,000
% of Sales 9.6% 10.2% 12.8%
Source: Nokia 2003 Financial Statements (www.nokia.com).
Case 12 • The Future of Nokia • 691
The ‘‘commodotization’’ of the cell phone is the first in
a one-two punch combination inflicted on Nokia. At the
same time prices were driven down, competitors were gaining
ground with sales from clamshell style phones. In attempts
to gain back market share, Nokia has lowered prices on its
own models. In the short term, this might stem the tide some-
what, but over the longer term, this will have an adverse
effect on Nokia’s bottom line. The profits that were Nokia’s
competitive advantage will quickly erode away, and they will
find themselves in the trenches with every other cell phone
manufacturer.
MARKET CHARACTERISTICS
At the same time Nokia has been adapting its pricing policy,
it has also reevaluated its lineup of cell phone designs as
well. Very quickly, they increased the number of new phone
designs being introduced in 2004. Among them are several of
the clamshell variety.
The answer to their design issues is not so simple as
just migrating over to the clamshell design. Cell phones have
become so much more than just voice-communication devices.
New cell phone models now offer a wide range of option possi-
bilities, including text messages, digital cameras, voice recogni-
tion, and PDA functionality. It is a safe assumption that in the
very near future we will see a ‘‘convergence’’ of such functions
and options to the point where we take for granted that all cell
phones would offer them. Nokia has shown they are commit-
ted to adequate research and development spending (Exhibit
8), but as their total revenue decreases, this will decline either
in aggregate or perhaps even as a percentage of sales as well.
Nokia can make a distinction between two separate
categories for the markets in which they participate. The
perception given by the press and trade journals is that
tastes for cell phone designs and functions are similar the
world over. One exception might be the popularity of the
‘‘push-to-talk,’’ walkie-talkie feature in the United States, but
even this is expected to spread to other markets. However,
a difference in purchasing behavior and prioritized needs
can be seen between consumers in developed markets and
developing markets.
Developed markets, such as the United States, Western
Europe and Japan, consist of consumers for whom cell phone
are now an accepted part of life. The adoption rate is high
across the population (over 60 percent penetration), and pur-
chasing habits are now seen to revolve around ‘‘replacement’’
occasions. The trend among cell phone users in these mar-
kets is to ‘‘trade up’’ to better models with more features,
such as color screens, digital cameras, or better ring tones.
Often, such purchases are not a necessity. The overall markets
have matured, but sales continue to grow because of this
‘‘upgrade cycle.’’
692 • Case 12 • The Future of Nokia

Developing markets, such as Latin America, India, and
China, offer great opportunity to cell phone manufactures as
the adoption rates among the population is still relatively low
but expected to grow dramatically. Growth in countries such
as India and China are predicted to help the number of mobile
phone users worldwide increase by 25 percent between now
and 2006. China, in particular, has been challenging for Nokia
as sales there have fallen in recent years. (See Exhibit 9.) This
can be attributed somewhat to the increase and success of
domestic cell phone manufacturers in China.
Regardless, Nokia is still the #1 handset manufacturer in
both India and China, with market share of 32.6 percent
and 15.6 percent, respectively. Competition in China comes
mainly from Motorola and, more recently, local vendors. The
Indian market more closely resembles the global trends, with
Samsung (29.6 percent) and LG Electronics (22.8 percent)
close behind Nokia, and Motorola, Sony Ericsson, Siemens
and Panasonic also playing a significant role.
Issues also exist in these developing markets with the exis-
tence, or lack thereof, of a communications infrastructure to
support wireless technology. This adds another layer of com-
plexity, as consumers cannot use cell phones if their country
does not have an adequate number of towers to convey the
wireless signal for reception.
Assuming clamshell phone designs are a panacea for all
their troubles would be a mistake for Nokia. In developed mar-
kets, the focus is on features and customization. Cell phone
users do not want the commonplace, traditional designs with
limited features. Again, the trend is towards ‘‘trading-up.’’ For
Nokia, this market is difficult to satisfy as they have positioned
themselves for large-scale production of standardized models
to realize economies of scale.
Compounding their economy of scale dilemma is the
emphasis placed in developing nations on basic functional
needs. Basic cell phone features, along with adequate battery
life and functional design are most needed in these markets,

EXHIBIT 9
NOKIA NET SALES BY GEOGRAPHIC AREA
(US$ MM) 2001 2002 2003

Finland 602 469 461

USA 7,466 6,204 5,951
Great Britain 3,734 4,137 3,581
Germany 2,664 2,459 3,055
China 4,546 3,726 2,677
Other 22,469 22,922 23,446
Total 41,481 39,917 39,171
Source: Notes to Consolidated Financial Statements, 2003 (www.nokia.com).

EXHIBIT 10
GLOBAL CELL PHONE MARKET SHIPMENT DATA
Global Mobile Phones Market Volume (Shipments in millions, 1998–2002)

Year Shipments (million) % Growth

1998 170.0
1999 255.4 50.2
2000 347.5 36.1
2001 389.4 12
Source: Datamonitor, November 2003 Global Mobile 2002 420.6 8
Phone Industry Profile.

EXHIBIT 11
NOKIA MOBILE PHONES FINANCIAL DATA
Net Sales Percent Operating Percent
Year (Euro Million) Change Margin (%) Change

1998 8,010 19.8

1999 13,182 65% 23.5 19%
2000 21,887 66% 22.3 −5%
2001 23,158 6% 19.5 −13%
2002 23,211 0% 22.8 17%
2003 (1st 3 Quarters) 14,913 n/a 28.4 n/a
Source: Nokia Annual Reports 1998–2004 2004 (1st 3 Quarters) 12,847 −14% 21.1 −26%
(www.nokia.com).

but users do not want to sacrifice style and looks either. In
addition to having to produce numerous models and feature
combinations for developed markets, Nokia also has to have
an appropriate range of models for its developing markets,
as well, keeping in mind, throughout, the need to maintain
Nokia’s reputation for quality and stylish design.
MANUFACTURING COMPLEXITIES
Nokia has benefited from its business model of large-scale
production at its own global factories to achieve economies of
scale and high profit margins. However, there will be increas-
ing pressure to manufacture smaller lots of customized and
adapted models as well as pressure to lower production costs.
The overhead involved with Nokia’s factory infrastructure will
make such cost goals difficult to achieve. The trend for com-
petitors has been to outsource production to low cost factories,
many of which are in China. This is compounded by the licens-
ing of cell phone technologies that allow such manufacturers
to product handsets under their own brand name.
WHAT IS NOKIA TO DO?
Nokia managed to unveil 27 new phones in 2004, 8 short of
their goal of 35 new models for the year. Jorma Ollila was not
thrilled with this, but at least it provided some fresh designs,
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 13
MAYBELLINE’S ENTRY INTO INDIA
THE COSMETIC INDUSTRY OVERVIEW
India, with a population of over a billion people, is a country
of contrasts. This population can be divided into two major
subgroups: Urban and Rural. India’s urban population is the
main engine that fuels the demand for various cosmetic prod-
ucts. Although Indians are strongly attached and committed
to their traditions, and culture, the media penetration and the
awareness of the western world is changing the tastes and
customs of India. The ‘morphing’ of India is subtle and the
changes are not visible for the first-time visitor. However,
the market liberalization process that began in 1991, along
with the crowning of three Indians as Miss World and Miss
Universe during the preceding four years, have made Indian
women conscious of their appearance. Consequently, the cos-
metic consumption patterns of Indian women have changed,
and this trend is fuelling growth in the cosmetic sector.
The Indian cosmetics and toiletries market grew by
8.7 percent in current value terms in 2001, with value sales
amounting to $2.8 billion. In 1999 the Indian cosmetics and
toiletries market grew 8 percent over 1998. Total value since
1995 was 54 percent in current terms, equating to 25 percent in
constant terms. Also, it may be imperative to understand the
This case was prepared by Heather Cipolone, Atul Patil, Rengasamy
Raja, and Brian Scanlon and updated by Sonia Ketkar of the Fox School
of Business and Management at Temple University under the supervision
of Professor Masaaki Kotabe for class discussion rather than to illustrate
either effective or ineffective management of a situation described (2004).
Case 13 • Maybelline’s Entry into India • 693
and more importantly, several clamshell models for the buying
public. Jorma was not happy to see his market share continue
to erode away throughout the year, but he knew he would not
be able to turn things around immediately.
The promise of emerging markets such as China and India
loom large, but does Nokia have what it takes to maintain their
foothold and manage their costs competitively? For years, the
strength of Nokia had been in the ownership of its factories
and the expertise of its workers. Would Nokia be able to
transfer that knowledge to lower-cost manufacturers in time
to stay on top? Jorma felt confident that they could, but won-
dered if that confidence was truly justified (see Exhibits 10
and 11).
DISCUSSION QUESTIONS
1. How can Nokia position itself in developing markets to
capture future market share (while maintaining economies
of scale)?
2. What must Nokia do to better position their mobile phone
business in developed markets?
3. Can Nokia maintain economies of scale in the developed
markets? Should it use outsourcing as part of its new
strategy?
fact that, the current deceleration of the double-digit growth
during the last decade signaled a significant shakeout. This
was also a reflection of a difficult year for the Indian econ-
omy, beset by an earthquake on January 26 in the state of
Gujarat, the slowdown of exports to the US after September
11,2001 and the decline of growth in industrial output to well
below 5 percent. The decline is also due to the extremely high
excise duty levels, which have remained at 32 percent the past
two years, as against a duty of 16 percent attracted by other
mass consumption items like soaps, detergents, hair oils, and
toothpastes. The growth in Nail enamels was seven percent in
2000-01, while that in lip color was 10 percent.
The increasing size of the middle-class population in India,
representing a growth in disposable incomes, has led to more
consumers for the cosmetics and toiletries market. Such con-
sumers are more inclined to purchase higher-priced products.
Due to the sluggish economy, at the onset it was very impor-
tant to increase sales volume by focusing on every manner
of promotional persuasion, from 2-for-1 deals, through give-
aways and fabulous holidays to massive discounts. This cut
across almost every major category and was endemic in the
mass market. A wry remark from an industry source summed
it up well: ‘‘The market has been spoilt by a series of schemes
and buyer loyalty is at rock bottom. Customers just wait for
the best bargain on any given day.’’
Most multinationals that entered the market have however
revised their estimates of the number of consumers able to
buy their products. Optimism has been tempered by a gradual
694 • Case 13 • Maybelline’s Entry into India
dawning of the fact that middle-class India is not as big or as
active as many marketers had believed.
INTRODUCTION
November 2, 1998 was a rewarding day for Geoff Skingsley.
Mr. Skingsley, the managing director of L’Oreal’s Indelor
unit, had worked tirelessly to bring L’Oreal’s wholly owned
subsidiary,—Maybelline to India. Mr. Skingsley said ‘‘India
is the last major piece in the Asian jigsaw for us because the
Maybelline brand has been in virtually every Asian country
and India was the big gap in that puzzle.’’ Furthermore, Mr.
Skingsley recalled the long, hard road to get to this point,
acknowledging, ‘‘Maybelline was a long development pro-
cess.’’ Maybelline faced a difficult situation upon its entry into
India, a country already endowed with an established leader in
the cosmetics field, Lakme Lever (a subsidiary of the Unilever
corporation).
COSMETICS CONSUMER CLIMATE OF INDIA
A market research company, Datamonitor, suggests that in the
period 1994 through 1998 all major categories of the Indian
cosmetics and toiletries market have been showing healthy
growth. Consumer expenditure on cosmetics and toiletries is
increasing following a surge in disposable income; this trend,
in turn, has led to volume growth. With greater frequency,
cosmetics are seen as a necessity rather than a luxury, and
the consumer age profile is changing, with approximately 45
percent of the population below 25 years of age. Conversely,
India’s population is diverse in terms of lifestyle and spend-
ing power—a point requiring careful consideration. Overall,
though, despite reports that a third of the population is too
poor to afford an adequate diet, modern industries steadily
gained strength.
Finally, another encouraging sign was the view of the Indian
Soap and Toiletries Makers Association. They felt that the
Indian market had a promising future. It was at a threshold,
facing phenomenal opportunities to increase the low levels of
product penetration. With such low penetration levels across
cosmetics and toiletries, it was clear that there was room
for many brands and manufacturers to profit as consumption
increases and the market itself grows.
TRADE TARIFFS AND BARRIERS
The climate for international expansion into India was a dif-
ficult one in the years from 1947 to 1991. During this time,
India’s import and export policies were such that a vast major-
ity of goods had to be imported under license. In 1991, India
initiated economic reforms to tide over the budget deficit,
balance of payments problems and structural imbalances in
several industry sectors of the economy. Despite these mea-
sures, India still imposed high tariffs as well as quantitative
restrictions on imports.
Gradually, these tariffs were reduced in the years follow-
ing 1991. Also, in 1994, India decided to allow non-Indian
companies to import flavor and fragrance compounds and
concentrates into the country for the first time. Prior to 1994,
companies could sell individual components (both natural and
synthetic) to India, but the compounding had to be done in
the country. Obviously, this was a favorable event in the eyes
of cosmetics companies as they could now import essential
compounds directly into the India.
Unfortunately for Maybelline, this ‘‘liberalization’’ became
sluggish in the late 1990s. In 1998, the excise duty for cosmetics
and toiletries was 30 percent and later rose to 32 percent in
1999. Also, for cosmetics and toiletries, the effective total
import tariff worked out to be about 90 percent. Sales tax
became an issue. Currently, in some Indian states, it is as high
as 15 percent. In addition, although peak customs duty rates
and quantitative restrictions on imports of consumer goods
had been reduced to conform to World Trade Organization
requirements, import duties on raw materials and interme-
diaries remained unchanged due to governmental revenue
deficits.
Other restrictions on cosmetics are brought forth by various
governmental agencies. The country’s Drugs and Cosmetics
Act govern the manufacture and sale of cosmetics and toi-
letries, while the Bureau of Indian Standards regulates the
quality of products. Packaging of products must feature the
price of the item and legislation exists concerning various
statutory markings to be made on packs.
POLITICAL CLIMATE
The political climate of India also plays a role in Maybelline’s
entry into the country. India is a democracy with a large num-
ber of political parties. India’s political system has for several
years been in transition from one-party dominance to a more
splintered picture (in which regional and caste-based parties
control most states) alongside a still unclear political pat-
tern at the center. Against this backdrop, a foreign company
has to navigate the many levels and factions of government.
Many times corruption ensues. The greatest immediate threat
to India’s governance is not tottering coalition governments
but corruption. The combination of a state-run economy and
weak political institutions created all too many opportunities
for crooked politicos and bureaucrats.
FINANCIAL MARKETS AND INFRASTRUCTURE
In 1998 the financial markets of India were not encouraging
for multinational expansion. In that timeframe, India’s finan-
cial sector still could not effectively mobilize and mediate
capital to respond to economic changes. Also, although much
improved since 1991, India’s equity markets are excessively
thin and volatile, and did little to inspire confidence on the part
of domestic or foreign investors. Bond markets are practically
nonexistent. Liberalization of the insurance industry, which
would greatly improve the investing of India’s substantial sav-
ings, has been stymied. Finally, India’s banking system was
flawed, with the dominant state-owned banks still carrying
bad loans amounting to 15 to 25 percent of their total.
Another constraint on growth was India’s poor infrastruc-
ture. Financing was been difficult. Ambitious plans to improve
power generation, telecommunications, ports, and roads were
thwarted by poor policies, indecision, and corruption. Of
eight ‘fast-track’ power projects initiated in 1992, only two
were producing (or close to producing) power. Telecommuni-
cations reforms was mired first in massive graft, and then in
battles over regulation; not surprisingly, many major foreign
companies retreated.
 Case 13 • Maybelline’s Entry into India • 695

COMPETITIVE LANDSCAPE 40 percent of Lakme’s customers expressed their willingness

to pay more in anticipation of superior quality.
The size of India’s color cosmetics market was $3 billion.
Despite a lukewarm growth over the past few years, the
While lipsticks accounted for nearly a third of the color cos-
industry continues to sustain a healthy growth rate of around
metics market at $ 1 billion, the market for nail enamels is
20 to 25 percent. The organized sector accounts for more than
estimated at around $1.1 billion. The remainder consists of
50 percent share of the Indian color cosmetics market. The
products such as mascara, eyeliners.
market is dominated by large domestic players and leading
The growth in the $3 billion color cosmetics industry has
international brands that are fiercely competing against each
dipped to single-digit levels of about eight percent in 2000-
other to gain market share. Lakmé, a domestic cosmetic brand,
2001, from 15 to 20 percent in the previous year. The growth of
currently dominates the Indian cosmetics scene. The indus-
individual brands, however, showed a different trend: While
try is witnessing a clash between the market leader Lakmé
brands like Revlon and Maybelline grew at strong double-
and an array of leading multi-national companies like May-
digit levels, Lakme has grown at a staid pace. Fired with the
belline, Revlon, Avon, and Oriflame who have established a
zeal of changing the complexion of the cosmetics market, they
significant presence through the launch of their international
were fuelling the change using satellite television, women’s
product lines and a growing popularity for their brands.
magazines and beauty pageants.
Consumer trends have indicated that the growth in the
Revlon, as per ORG (value) urban only market for lips
Indian cosmetic industry has been largely contributed by the
and nails, grew at 57 percent, and Maybelline at 31 percent.
low-to-medium priced categories rather than the premium
Lakme and Elle 18 registered growths of eight percent and
category. Industry experts note that although both the pre-
one percent, respectively. The growths have been higher in
mium and mass-market segments have registered considerable
the case of Revlon and Maybelline, as these were taken on a
growth, the growth opportunities in the premium segment
smaller base, feel industry analysts. In the urban lips and nails
have not been as promising as the mass market segments.
market, ORG reported a growth of over 10 percent in 2000,
Being a niche market the premium segment constitutes a
two points behind the 12 percent growth witnessed in 1999.
small portion of the market base and offers less scope for
Brands such as Revlon and Maybelline are seen to be
higher volume. The growth in the segment has been mainly a
outperforming market growth by five times and three times,
result of consumers upgrading from mass to premium products
respectively, as per ORG figures: urban plus rural (lips and
rather than an increase in consumption per se.
nails only). However, a case of downtrading was witnessed
The mass-market segment on the other hand presents
with the local unorganized sector bringing the growth rates
better prospects and a higher scope for increasing volumes.
down. The market share of Lakme in lip color stands at 42 per-
The segment constitutes a much higher market base. Because
cent in value, as per ORG. Revlon share was at 10.6 percent,
of the low price, products in these categories are more likely
and that of L’Oreal 7.4 percent. In nail color, Lakme share was
to be tried by consumers than products in the premium seg-
at 30.5 percent, while that of Revlon was 5.7 percent. L’Oreal
ment. The market as a whole remains largely untapped and
share stands at 3 percent.
represents huge growth opportunities for companies. While
The growth, feel industry observers, can be fuelled by more
some top players like Lakmé have major presence in both the
and more performance based technological innovations. May-
mass and premium market segments others like Maybelline
belline, for instance, launched Shine Free Liquid Foundation
have focused on the mass-premium end. Most companies rely
(Face Make-Up). There had also been many initiatives with
on conventional channels of distribution like retail markets.
mini sizes in the market, especially in the nail category. These
However players like Avon and Oriflame through their net-
provided successful short-term initiatives but did not appear a
work of well-trained representatives have concentrated on
successful strategy for longer-term value growth in the market
direct marketing.
place, felt industry observers. Maybelline as a group commit-
ted to introducing initiatives, which were new, different, and Retail Marketing
better than what on offer in the Indian cosmetic market. These
Lakmé is well established in the Indian cosmetics market
initiatives represented the latest technology in lips, nails, face
and has been a popular brand with three generations of
and eyes and are supported by strong media. This strategy
women. The brand has been around for more than half a
represented the best way forward for both consumer choice
century now and has led the market over the years. Owned
and value growth in the urban market.
by the Indian subsidiary of Unilever—Hindustan Lever Lim-
Industry analysts expects the urban market (lips and nails)
ited (HLL)—Lakmé Lever currently dominates the Indian
to grow at over 10 percent this year (2003), and the overall
color cosmetics scene with over 50 percent in market share. In
urban market for lips, nails, face and eye products at over 12
the color cosmetics market Lakmé offers a variety of products
percent growth. The market for cosmetics in India is charac-
ranging from the popularly priced mass range under the ‘‘Elle-
terized by high volume sales of low-end products, while at the
18’’ brand name to the mid-priced to premium products under
same time the legendary emerging middle-class has generally
‘‘Ultra,’’ ‘‘On Top Of The World,’’ and ‘‘Orchid’’ ranges.
been fuelling demand for premium cosmetics. Most major
Priced at a premium to the Ultra and Elle 18 ranges, Top
cosmetic companies profess the need to tap the upper market
of the World, has been Lakmé’s response in taking on Inter-
segment and create exclusive products, but market studies
national players like Maybelline while supplementing and
reveal that most cosmetic users are unwilling to cough up
providing synergy to the Lakmé portfolio. The range consists
more to buy these exclusive products. According to a recent
of products with new formulations and additional features like
survey by Maybelline’s strongest competitor ‘‘Lakme,’’ only
696 • Case 13 • Maybelline’s Entry into India
the vitamin-enriched lipstick and long-stay nail enamel that
enhance the Lakmé brand and promote a superior image with
tangible consumer benefits in tune with international players.
Elle 18, Lakme’s mass brand, dominates the Indian mass
color cosmetics market with its affordable pricing and easy
availability. The range targets the young and trendy teenage
segment. Positioned as an economically priced ‘‘rebel’’ brand
for the youth, Elle 18 is the only organized brand in this
segment. Elle 18 accounts for about 30 percent of Lakme’s
color cosmetic sales and enjoys a strong market share of
over 25 percent. Elle 18 products are sold in the eye, lip and
nail category. The brand has registered a huge growth and
accounts for over 45 percent share of the nail enamel category.
As one retail consultant notes, with the launch of many
new products and several international brands, the Indian
cosmetics market is approaching product quality parity and to
a certain extent price parity. Therefore it has become essential
for companies to look into the service element to differentiate
their brands. Lakme has leveraged its brand name by estab-
lishing a chain of beauty salons across India through which
the company makes the brand interact with its customers and
provide them with expert service using well-trained beauti-
cians. The salons help Lakme strengthen its brand and acquire
new customers. The company also hopes to develop customer
relationships and brand loyalty while allowing it to exper-
iment with new products. Apart from print and television
media, Lakme uses major fashion events like the Lakme India
Fashion Week to actively promote its products. It organizes a
series of workshops and fully equipped Lakme salons at the
venue and comes out with a special range of cosmetics for the
fashion week. Over the years, Lakme Lever has established a
strong presence in the retail front. Both Lakme and Elle-18
brands enjoy a combined distribution strength that spans over
65,000 outlets throughout the country.
Revlon holds the second largest share of the Indian color
cosmetics market. Launched as a joint venture between Modi
Mundi Pharma and Revlon, USA, Modi Revlon accounts
for over 20 percent share of the domestic color cosmetics
market. The company has registered a strong growth rate
of about 50 percent in the past few years. This has been a
result of Modi Revlon’s efforts to restructure and revamp
its operations through a plan that calls for achieving higher
cost efficiencies, emphasizes indigenized production and an
enhanced distribution network. While it continues to import
chemicals and certain packaging material, three-fourths of its
production is localized allowing it to reduce costs and save
on duties. It restructured its sales teams to focus on specific
product categories and tap unit sales in smaller towns. Revlon
currently accounts for 19 percent of the domestic lipstick mar-
ket and 12 percent of the nail enamel market. Lipsticks have
been the best selling product line with Revlon’s color cos-
metics portfolio. Modi Revlon intends to consolidate its retail
strength in the premium segment and increase the number
of Beauty Advisors. It aims to drive growth in the premium
segment through its ColorStay brand, which includes several
new launches.
In December 2002, Revlon entered the mass color cosmet-
ics market with its StreetWear cosmetics brand. The brand
targets the fashion seeking teenage population between the
ages of 17 to 22. StreetWear is also globally positioned at the
young and trendy shoppers and includes several products in
the face, eye, lip and nail color categories. Modi Revlon has
carefully positioned the brand to avoid any cannibalization
of sales from its flagship Revlon brand and has affordably
priced the products to gain market access. The company’s
decision to enter the teenage segment with an international
brand has been to directly compete with the mass market
leader Lakme’s Elle 18 brand. The StreetWear range consists
of eight products, which include categories that Elle 18 does
not have a presence, like face makeup, and eye shadow.
Revlon also introduced mini ranges of its color cosmetics
to drive volumes in the mass segment. The company’s strategy
to launch relatively lower priced smaller packs of its lip and
nail products has been seen as a setback to Lakme’s unbeat-
able price advantage. This has been a strategy that very few
players could afford to circumvent. With retail presence in
10,000 stores Revlon is beefing up its distribution network
to be able to compete against Lakme and Elle 18 products
currently stocked in 65,000 outlets. Modi Revlon has set out
to undertake a market driven and well-researched approach
to introduce almost all Revlon products in the Indian market
within the next five years. Depending on the market needs, it
also plans to increase its current level of investments in the
domestic market.
Direct Marketing
The Indian color cosmetics scene has also witnessed con-
siderable presence and aggressive marketing efforts by a
host of direct to consumer and network marketers. The seg-
ment includes international players like Avon, Amway, and
Oriflame and domestic players like Lakme Lever and Modi-
Care. When compared to the retail market, the direct selling
accounts for a relatively smaller segment of the domestic
color cosmetics market. Industry reports have ranked the
direct selling segment among the highest in term of growth
rate. The segment has registered an astonishing growth rate
of 54 percent. Driven by consumer needs, companies like
Oriflame have invested in world-class technical centers and
manufacturing facilities to meet stringent international stan-
dards for the development and manufacture of cosmetics.
Currently Amway leads the direct marketing category with
annual sales of Rs 6.25 billion. While top players like Modi
Revlon are still contemplating entry into the direct selling
market, industry giant HLL markets its color cosmetics range
under the Aviance brand. The thrust for HLL has been to
educate consumers and offer them with customized solutions.
While the range of customized beauty solutions are developed
at the Unilever Beauty and Skin Innovation Center in U.S.
the products are locally manufactured. Aviance currently has
a base of 75,000 specially trained consultants. Adopting a
pricing based on value HLL aims to go down the population
strata reaching a larger target audience.
MAYBELLINE’S GLOBAL STRATEGY
AND POSITIONING
Maybelline Inc. markets a variety of products across four
broad categories, the eye make-up products, facial make-up
products, lip products and Nail products. The company oper-
ates under the global cosmetic and toiletries industry of which
the U.S. segment has the world’s largest market share. The
industry is characterized as being very mature and highly
competitive with the top players fiercely competing against
 Case 13 • Maybelline’s Entry into India • 697

EXHIBIT 1
FOLLOWING ARE THE PRICES OF THE MORE POPULAR PRODUCTS OF THE KEY PLAYERS
IN THE CATEGORY
Lip Products
Maybelline Revlon Lakme Chambor
Product Price ($) Product Price ($) Product Price ($) Product Price ($)
Moisture 2.15/2.45 ColorStay lip- 4.25 Lipsticks 2.00 Lipsticks 6.25
Whip sticks
lipsticks
Non- 4.20/4.25 ColorStay liquid 4.35 Liquid lip 3.25 Lip pencils 3.35
transfer lipsticks colors
lipsticks
ColorStay lipliner 3.80 Lip liners 0.85 Lip crayon 7.25
Moon Drop 3.95
lipsticks
Mini lipsticks 2.15

Nail Products
Maybelline Revlon Lakme Chambor
Product Price ($) Product Price ($) Product Price ($) Product Price ($)

Ultimate 1.60 Top Speed nail 1.80/1.90 Nail enamel 1.25 Nail enamel 4.10
Wear nail enamel
enamel
Mini nail enamel 1.25 Nail enamel 0.70
(8 ml) remover
Nail enamel 1.85/2.20
(15 ml)
Nail enamel 1.15/1.35
remover

Eye Products
Maybelline Revlon Lakme Chambor
Product Price ($) Product Price ($) Product Price ($) Product Price ($)

Non- 3.8 Colorstay liquid 5.35 Eyeliners 0.85 Silver shadow 11.25
transfer eyeliner (compact)
eye liners
Curl 2.15 Colorstay self- 3.8 Mascara 1.95 Trio eye shadow 7.95
mas- shapeing
cara eyeliner
Wonder 3.35 Eye shadows 4.75 Kajal 0.55 Eye liner 5.65
curl mas-
cara
Easy eye 3.15 Eye pencil 0.25 Mascara 5.65
lining pen
Eye shadows 2.25 Twin Sharpner 2.10

Face Products
Maybelline Revlon Lakme Chambor
Product Price ($) Product Price ($) Product Price ($) Product Price ($)

Express 6.15 ColorStay 4.25 Compact 1.50/4.00 Blush on 8.10

make-up Concealer
3-in-1 stick
Shine-Free 3.25 ColorStay 6.15 Foundations 1.50, Glitter stick 3.85
foundation foundation 1.65,
1.75
Moisturising 1.7 Face powder 0.50 Silver dust 3.85
foundation
Moisturising 3.15 Blushers 2.15
compact powder
Blush-on 4.15
698 • Case 13 • Maybelline’s Entry into India
each other to increase their market share. Maybelline line of
products is primarily mass marketed in the several product cat-
egories it serves. The company is a leader in the mass-market
color cosmetics business.
The global cosmetic business is about $23.4 billion in sales.
L’Oreal Corporation owns 23 percent in 1999. Maybelline
is the number one mass-market brand globally, holding
about 18.9 percent of a $3 billion market. Marketers con-
tinue to strive hard to develop a culture that matches the
personality of the target audience who tend to evaluate
the brand based upon their personal image. In order to
strengthen brand equity in a highly competitive market place,
adopting the right culture has become an important fac-
tor in present-day marketing strategies. Creating a culture
of constant need to enhance natural appearance and desire
an improved self, cosmetic companies struggle against each
other to encourage women to work miracles adapting their
brands.
L’Oreal’s Goal was to make Maybelline a leading global
mass-market brand. Its international business contributes to
over 45 percent of total sales represented in about 90 coun-
tries worldwide. Maybelline is positioned as the leader of
mass-market cosmetics targeted at women between the ages
of 15–49 at a reasonable price. It is globally branded with
the ‘‘Urban American Chic Image.’’ Maybelline has since
achieved a third position in the India market with this posi-
tion. Lakme Lever commands a 45 percent market share and
Modi Revlon is third with about 10 percent.
Maybelline’s leadership position is significantly attributed
to its global branding approach, allowing it to speed mar-
ket growth in the mature consumer products industry. It has
made every effort to position and promote its product lines
under trendy ‘‘New York’’ Maybelline brand image. Glob-
ally, Maybelline has been heavily promoting its trendy New
York image. The company has effectively aligned its strategy
with that of its parent L’Oreal in conveying the appeal of
different cultures through its products. Instead of taking a
homogenous brand approach to making the products accept-
able across international markets, the company has stressed
the importance of embodying their country of origin. With
Maybelline, upon its acquisition, L’Oreal began a complete
makeover including moving the headquarters from Memphis,
TN. to New York City in an effort to stamp the ‘‘urban Ameri-
can chic’’ image all over Maybelline products to promote their
U.S. origins. Maybelline has been making efforts to reach a
bigger target audience across a broader range of income and
cultures.
Maybelline’s international strategy emphasizes its Ameri-
can heritage. It continues to promote its ‘‘Trendy New York’’
image in all countries. This global strategy promotes a uniform
image and strong brand recognition worldwide. In India, May-
belline is following the international strategy with a New York
attitude. The American image in India was found to have a
positive effect. Maybelline has continued with the same global
branding in India using supermodel Christy Turlington and
Sarah Michelle Gellar to promote its products. Ads were
printed in Indian editions of Elle, Cosmopolitan, and Femina
and TV spots were conducted on Star Plus.
This approach has proven to work by placing Maybelline
in second position. However, in order to succeed in this mar-
ket, Maybelline needs to be able to be price competitive with
other local products. Pricing is critical in India. Currently,
India has positioned Maybelline as an aspirational product
with a premium price.
PRICING
Maybelline, a subsidiary of L’Oreal, prices its products based
on the country in which it is selling them. In the United States,
Maybelline is priced mid-range of the cosmetics market with
its main competitor being Revlon. It is sold everywhere from
drug stores to discount cosmetics stores to boutiques. Prices
for various products range from $3.50 to $7.00. However, in
emerging markets such as India, Korea, and Russia, May-
belline is viewed as a premium brand. Maybelline competes
with Lakme, an Indian company, and Revlon, another US
competitor. Lakme leads the market mainly due to the larger
price differentiation.
One of the key components to Maybelline’s success for
India is to have the right distribution and the right pricing-
value relationship. Although the Indian cosmetic market is
growing at a rate of 15 to 20 percent per year, pricing dynam-
ics are very complex. India still has widespread poverty and
an extremely low per capita equating to extreme price con-
scious individuals. Maybelline is having a difficult time being
consistent with the pricing strategy that they maintain in other
markets as being affordable. A couple of issues are influ-
encing this: high import tariffs and high taxes of about 15
percent on consumer products. Tariff rates were about 450
percent in the 1990’s, which then declined to about 32 per-
cent in 2001 for skin care and cosmetics toward the end of
the 1990’s. Tariffs are expected to go down again since India
is now a member of the World Trade Organization (WTO)
to about 15 percent, which will then make Maybelline more
affordable and therefore, more competitive with the current
market.
Competitive Pricing
Exhibit 1 displays a pictorial view of the competitive pric-
ing in this market. The mass market for lipsticks (price
range: $2 to $4.50) is 43 percent of the total lipsticks mar-
ket. The prices that range below $2 represent roughly 48
percent of the market. The mass premium segment (price
range $5 and higher) is just 9 percent of the total lipsticks
market. Maybelline has a market share of 80 percent, accord-
ing to ORG, with the balance held by Revlon, Chambor, and
Lakme’s Orchid.
Lakme’s product range consists of the Elle-18 line (priced at
around $1) and the medium-priced Ultra line (at around $1.75)
to the premium Orchid range of color cosmetics (priced in the
range of $3.5 to $5.5). French multinational L’Oreal India
prices range from $6.5 to $32. By the end of 2001, it expects
nearly 50 cities to be selling the products. Maybelline recently
introduced an Express Make-Up priced at $6.5. L’Oreal’s
product of makeup currently available in the market is priced
at the premium end at $12.5. The brand is currently available
in 4,000 outlets. Maybelline New York globally has 900 SKUs
in colour cosmetics. In competition with L’Oreal’s Maybelline
range of ‘transfer-resistant’ lipsticks, Revlon has rolled out
‘ColorStay’ lipsticks priced at $6. The lipsticks are thus at a
high premium to the Maybelline range priced at $4.5. The nail
enamel market, one of the fastest growing segments in the
cosmetic industry, is segmented into three groups:
 Case 14 • Yahoo! Japan • 699

• The mass premium segment priced above $3, and 3. Free Standing Stores
dominated by brands such as Chambor, Orchids, and 4. Health Food Stores
Revlon, Maybelline. 5. Salons
• The mass-market segment priced between $1 and $3, with SEGMENTATION
brands such as Lakme and Maybelline.
The color cosmetics market can be broadly divided into two
• The lower segment, priced below $1, accounting for 75 per- segments:
cent of the total market, this popular segment consists of
Elle 18, Tips & Toes, and other regional brands. • Organized sector dominating 36 percent of the market.
DISTRIBUTION • Unorganized sector catering to 64 percent of the market.
There are three categories of channels of distribution: Target Market
Age
Prestige—Department stores, specialty stores, and chain
department stores, such as Shoppers’ Stop, VAMA, West- Youth segment (15–24 yrs): Maybelline, Revlon, Elle—18
side, and Bombay Stores. Core target (24+): Maybelline, L’Oreal, Revlon, Chambhor,
Broad—Drug stores, food stores, cosmetic discounters, Lakme Radiance
warehouse clubs, and mass merchandisers. Examples are
Purchasing power
Satyam, Haiko, and Sahkari Bhandar.
Alternative—is identified by five different marketing Affluent segment: Maybelline, L’Oreal, Chambhor, Aviance,
methods: Orchids
1. Direct Sales Middle segment: Lakme Radiance
2. Direct Mail/TV/Print Lower segment: Elle-18

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 14

YAHOO! JAPAN
OVERVIEW its online auction services. Management also recognized the
strategic importance of providing broadband Internet service;
During the Internet ‘‘bubble’’ of the late 1990’s, Yahoo! Japan
in addition to being a source of revenue, broadband functioned
experienced tremendous revenue growth; the market value of
as a digital distribution channel, allowing greater access and
the company skyrocketed as investors championed the Com-
profit potential for the company’s other fee-based services.
pany as the leading Internet advertising channel in the country.
Yahoo! Japan’s future success was dependent upon adopting
Managers and investors believed that Yahoo! Japan’s value
a successful diversification strategy, entering new markets,
proposition held immense profit potential. The Internet crash
and acquiring new revenue streams.
of 2000, however, and a loss of faith in the sustainability of
Yahoo! Japan’s advertising revenue caused the market value Yahoo Inc. and Softbank Corporation
of the company to plummet. While the company continued to
Founded by Jerry Yang and David Filo, Yahoo! Inc. is the
realize positive revenue growth overall, revenues from Inter-
leading portal site and Internet-related service provider in
net advertising decreased more than 8.4 percent between 2000
the world. The company offers a variety of services, which it
and 2001. The decline in Yahoo! Japan’s core business func-
categorizes into six divisions: listings, online shopping, media
tion caused immediate concern among managers, and forced
information, enterprise solutions, auctions and broadband
the company to re-evaluate its business practices.
service. The company offers its basic services without charge
Management quickly recognized the vulnerability of the
to its customers, but also offers a variety of fee-based pre-
company’s dependence on a single dominant revenue stream.
mium services. In addition, Yahoo! Inc. generates revenues
While Yahoo! Japan had expanded the scope of its initial
from selling advertising and marketing services which are
Internet services, it had not committed to a specific diver-
incorporated throughout its portal site.
sification strategy. By 2001, management accepted the need
Early in its developmental stage, Yahoo! Inc. aligned with
to enhance its business portfolio with new business units
Softbank Corporation of Japan, a leading technology invest-
and made the decision to aggressively seek revenues from
ment firm. Softbank acquired 5 percent of Yahoo! Inc.’s shares,
and then continued to strengthen its ties with the company.
Currently, Softbank holds 37 percent of shares in Yahoo! Inc.
This case was prepared by Andrew Huang, Ryan Kanda, Sam Jin Kim,
Kang Suh Lee and Keith Sakuda of the University of Hawaii at Manoa Yahoo! Japan
under the supervision of Professor Masaaki Kotabe for class discussion
In 1996, Softbank unveiled Yahoo! Inc.’s first international
rather than to illustrate either effective or ineffective management of a
situation described (2003). expansion with Yahoo! Japan. Operated as an independent
700 • Case 14 • Yahoo! Japan

EXHIBIT 1
SUMMARY OF FINANCIAL RESULTS
2001 2002 % of Change

Net Sales (¥ M) 31,497 59,095 87.6%

Yahoo! BB 13,286 22,245 67.4%
Auction 2,416 11,080 358.6%
Portal and others 26,665 25,770 (3.4%)
Cost of Sales (¥ M) 8,963 15,682 75.0%
Gross Profit (¥ M) 22,534 43,413 92.7%
Operating Income (¥ M) 10,406 24,072 131.3%
Net Income (¥ M) 5,868 12,096 106.1%
EPS (¥) 49,775 25,154 (49.5%)
ROE (%) 40.7 48.4 18.9%
Source: Company annual report in 2001 and 2002.

EXHIBIT 2
5 YEAR STOCK PERFORMANCE OF YAHOO! JAPAN

52 Week Moving Average

Yahoo! Japan

26 Week Moving Average

JASDAQ
Nikkei Index

company, Yahoo! Japan retained the format of Yahoo! Inc.,
but tailored it for Japanese users. Under an agreement with
the parent company, Yahoo! Japan pays 3 percent of gross
profits as a royalty fee. In exchange, the company is entitled
to freely utilize the technology, research and development,
and characteristic features of Yahoo, Inc., including e-mail,
customized homepages, Web communities, chat, and other
various services. Additionally, Yahoo! Japan benefits from
the parent company’s considerable branding leverage.
Summary of Financial Results in 2002
In financial year 2002, Yahoo! Japan recorded ¥59 billion
in sales and ¥12 billion in net income. This represented an
increase of 88 percent and 106 percent, respectively, from the
previous year. On May 14th, 2003, Yahoo! Japan stock was
valued at ¥1,280,000 per share.
PC and Internet Adoption in Japan
In 2001, 58 percent of Japanese households owned a personal
computer (PC). This percentage increased 7 percent from the
previous year, but was less than the 13 percent increase from
1999 to 2000. According to another survey, Japan’s household
PC ownership in 2002 was 70.9 percent, significantly lower
than North America’s 89.9 percent and Hong Kong’s 93.6 per-
cent. As of February 2002, Japan had over 40 million Internet
users, a 62.4 percent penetration rate, up from 46.5 percent in
2001.
Yahoo! Portal Services: Market Entry
Yahoo! Japan was originally positioned as a portal service
similar to its U.S. parent site: a powerful Web search tool
combined with a variety of free user services. Advertising was
the company’s main source of revenue. While both compa-
nies shared similar technical aspects, Yahoo! Japan quickly
surpassed the performance of its parent company. By the year
2000, Yahoo! Japan’s market share was double that of Yahoo!
U.S., and annual revenues had increased threefold. Along with
its powerful branding image, Yahoo! Japan’s first mover status
greatly contributed to its success. ‘‘We are actually trying to
figure out why our share of the Internet traffic in Japan is so
 Case 14 • Yahoo! Japan • 701

EXHIBIT 3
RATIO OF HOUSEHOLDS POSSESSING PCS AND USING THE INTERNET (1996–2001)
Diffusion of the
Number of Respondent Proportion of PC Ratio of Households Internet per 100
Year Households Ownership (%) Using the Internet (%) Population (%)

1996 4,159 22.3 3.3 ... Source:

Information
1997 4,443 28.8 6.4 9.2 and Commu-
1998 4,098 32.6 11.0 13.4 nications
1999 3,657 37.7 19.1 21.4 Policy
Bureau,
2000 4,278 50.5 34.0 37.1 MPHPT,
2001 3,845 58.0 60.5 44.0 Communica-
2002 54.5 tions Usage
Trend Survey.

EXHIBIT 4
JAPANESE INTERNET USER TREND
(Unit: millionpersons)
50

Video Research Netcom

40
Japan Research Center
(PC only)

30

20

Media Metrix

10

Net Ratings
(Household·PC only)
0
Dec 96 Jun 97 Dec Jun 98 Dec Jun 99 Dec Jun 00 Dec Jun 01 Dec Jun 02
Source: Research reports by respective agencies

high,’’ said Masahiro Inoue, president and CEO. ‘‘One of the
reasons is that in Japan, we do not have America Online or
[Microsoft’s] MSN.’’
Yahoo! Portal Service: New Maneuvers
In 2001, Yahoo! Japan adopted a strategic business unit (SBU)
concept; what was previously recognized as advertising and
‘‘other revenues’’ was broken down into three different divi-
sions: listing, shopping, and media. Listing services defined
the online directory service where user searches would dis-
play business Web addresses prioritized according to fees
paid; shopping services defined the growing online shop-
ping segment; and media services consisted of the free and
premium content offered on the Web site, including news,
entertainment, and web-community services (e-mail, instant
messaging, etc.). By designating different business divisions,
Yahoo! Japan enabled timely decision making and optimal
use of resources.
Yahoo! Portal Services: Present and Future Issues
Though Yahoo! Japan enjoyed years of growth and prof-
itability, its market dominance was quickly undermined by an
ever-increasing number of new portal sites. While most of the
new entrants consisted of major international companies such
as MSN, Infoseek, and Lycos, the most formidable challenger
in Japan has been a domestic service, Goo, owned by NTT-
X. Quick to respond to the competition, however, Yahoo!
Japan recently reached agreements with two popular portal
702 • Case 14 • Yahoo! Japan
companies, Google and Overture. Under the agreement, both
paid-search engines would provide Yahoo! Japan with pre-
mium listings, with revenues generated to be divided between
the partners.
As a result of heightened competition and diluted market
power, Yahoo! Japan’s online advertising revenues dropped.
While the shopping division was not strongly affected by the
decrease in revenue, listing and media division earnings fell
precipitously: 80 percent to 90 percent of their revenues were
directly linked to advertising. Such circumstances continued
to raise concern over the long-term sustainability of Yahoo!
Japan’s portal services.
Another concern for Yahoo! Japan is the growing market
in mobile Internet access. Led by NTT DoCoMo’s i-mode ser-
vice, Japan was one of the first countries to offer viable Internet
access over mobile phones. Major portals like MSN and AOL
are now providing search engines and content services, with
Yahoo! Japan also vying for space in the mobile realm. As
the contest for the market intensifies, Yahoo! Japan is likely
to develop more innovative services that are compatible with
mobile systems.
Yahoo! Japan may also come under pressure from inter-
nal sources. Its major shareholder, Softbank, is aggressively
expanding its investments in a number of Asia- region Internet
ventures. Many of these ventures are Yahoo! Japan’s direct
competitors. This may create future conflicts of interest as
the companies begin to cannibalize each other’s revenues and
market share.
Yahoo! Auctions: Market Entry
In September of 1999, Yahoo! Japan entered the online auc-
tion market in Japan. An online auction is a virtual forum
where individuals and businesses interact, and goods and ser-
vices can be bid upon, bought, and sold. For this service,
the Internet ‘‘marketplace’’ provider generally receives a per-
centage fee of sales as commission. Historically, this type of
transaction had been eschewed by the Japanese consumer;
second-hand goods and the lack of a branded store identity
would have condemned this service to failure. Therefore, for
Yahoo! Japan’s online auction venture to be a success, a fun-
damental cultural shift had to occur. This shift occurred in
Japan for a number of reasons, including: Japan’s prolonged
economic slump; the emergence of environmental awareness
and the growing popularity of ‘‘recycle’’ second-hand shops;
and the strong, enduring collectibles market.
Yahoo! Japan began its online auction service at the insis-
tence of Jerry Yang, the co-founder of Yahoo! Inc. Yang
realized that the auctions niche had yet to be filled there. The
Company’s goal was to be the first mover into the Japanese
market—a key strategic move as Yahoo! Japan was soon to
discover.
Yahoo! Auctions: Competition and the Case of eBay
In February 2000, eBay entered the Japanese online auction
market, five months after Yahoo! Japan. eBay is the world
online auctions provider leader, controlling the number one
market share in the eighteen countries it operates in. Several
other smaller-market Japanese companies also operated in
the online auctions arena, namely Rakuten Ichiba online mall
and Bidders online auctions site. eBay immediately struggled
with its Japan auction venture, and could attain no higher than
a fourth place market position; Yahoo! Japan auctions were
number one. By March 2002, barely two years after its entry,
eBay pulled out of the Japanese market, citing its continued
losses and Yahoo! Japan’s market dominance as reasons for
its departure.
While a great deal of Yahoo! Japan’s success can be
attributed to its first mover status and the leveraging of its
company branding and integrated networks, the company’s
pricing strategy was a key element. In contrast to eBay, which
opened its services with a percentage fee charge (between 1.25
percent and 5 percent of the transaction value); Yahoo! Japan
began in September 1999 by offering its services for free.
Only in May 2001, twenty months after its introduction, did
Yahoo! Japan implement a ¥280 membership fee for users of
its auction services. This was followed by a ¥10 per item listing
charge beginning in April 2002, and a 3 percent transaction fee
in May 2002. Each fee imposed resulted in a short-term drop
in users; shortly thereafter, however, the company regained
its users and continued its dominant position in the Japan
market. Currently, Yahoo! Japan controls over 80 percent of
the online auctions market in Japan.
Yahoo! Auctions: Future Issues
As of March 2003, there are 10.34 million unique users that
browse Yahoo! Japan auction sites, and 2.6 million registered
users that buy and sell items. The site averages over 3.35
million items listed at the end of each month, and cycles
through 11.09 million items during that time. Over ¥35.8 bil-
lion (approx. $303 million) in transactions volume occurs each
month, with a successful list-to-sell rate between 42 percent
and 53 percent. Additionally, 1,174 online merchants have
signed with Yahoo! Japan to take advantage of its online
auction services.
Yahoo! Japan online auctions segment must be concerned
with possible moves made by its competitors. A merger
between the number two and three market share holders,
Rakuten and Bidders, has been rumored for some time. Fur-
thermore, the re-entry of eBay into the Japanese market
remains a strong concern: eBay is the largest online auction
company in the world and Japan is the second-largest Internet
market in Asia. Before its departure, eBay had also consid-
ered acquiring Rakuten or Bidders, and may do so upon its
reentry.
Another concern is the potential increase in illegal or
fraudulent buying and selling practices over online trans-
actions. Such practices would erode consumer faith in the
online forum and drive down demand. In November 2002, the
Japanese legislature passed law reforms intended to prevent
Internet auction crimes. Independently, Yahoo! Japan also
imposed a strict registering system which confirms identities
of participants and maintains all auction records. Further-
more, Yahoo! Payment was created, which acts as an escrow
service to protect both buyers and sellers.
Yahoo! BB: Market Entry
Prior to Yahoo! BB’s entry into the broadband market, DSL
penetration in Japan was relatively low. At the time of the
division’s entry, there were approximately 500,000 users of
DSL nationwide, according to the Japanese Ministry of Public
Management, Home Affairs, Posts, and Telecommunications.
At that time, the average monthly fee for DSL service was
 Case 14 • Yahoo! Japan • 703

around ¥6,000, a cost great enough to discourage high rates of Yahoo! BB: Present and Future Issues
subscription.
While the Yahoo! BB division has performed well, the value
Upon entering the market, however, Yahoo! BB offered
derived from the division’s high revenues are offset by its
an introductory rate of ¥2,280 a month. The company’s service
low profit margins. Unlike the auctions and listing divisions,
was cheaper and faster than the market share leader’s 64 kbps
broadband has considerable marginal costs, since Yahoo!
ISDN service. In January 2002, three months after its entry,
BB must lease its telephone lines from NTT. The company
Yahoo! BB claimed 500,000 out of approximately 2 million
has also been subsidizing its own costs in order to offer
national subscribers. Note that there was a 1.5 million sub-
low subscription rates. Moreover, Softbank has aggressively
scriber increase during that time due to competitor response
marketed Yahoo!’s ADSL service, saddling the company
to Yahoo!’s initial price offering. Other DSL services, such as
with significant financial losses. It has been estimated that
Asahi Net, eAccess, Sony’s So-Net, and NTT, halved average
attracting a single, new ADSL subscriber costs the Yahoo!
rates to approximately ¥3,000 a month, and increased their
Japan and Softbank ¥37,000.
service speeds in order to remain competitive. This made
It also appears that the competition is beginning to catch
ADSL a more promising technology for many users, and the
up with the Yahoo! BB: For the first time, in April 2003, NTT
result was a rapid aggregate increase in subscriptions.
ADSL signed more new users than Yahoo! BB, with 196,000
ADSL has supplanted cable as the dominant broadband
and 184,000 users, respectively. Meanwhile, the growth rate
technology in Japan, largely due to Yahoo! BB’s pricing strat-
of ADSL subscribers is projected to slow as soon as late 2003,
egy and resultant market responses. As of the first quarter of
so the phenomenal expansion of broadband is not expected
2003, there were 5.5 million ADSL users out of the total 9.4
to continue.
million broadband users in Japan. Of the 5.5 million, Yahoo!
In addition, the viability of future services offered by Yahoo!
BB has 2.36 million users, making it the leader in ADSL mar-
Japan is still in doubt: VoIP service, for instance, is contingent
ket share. NTT’s ADSL service has 1.43 million subscribers,
on a high adoption rate of broadband and a shift from conven-
making it second in market share with just over half of Yahoo!
tional telephone service to VoIP. While the company hopes
BB’s base. The remaining 1.7 million users are spread over a
that broadband will provide additional revenue streams in the
large number of other providers.
future, only time will tell if its strategy will succeed.
Yahoo! BB: Motivations
OVERALL EVALUATION
The broadband division has become a large segment of Yahoo!
Yahoo! Japan’s diversification strategy was highly successful.
Japan’s overall sales revenue. During the three-month period
Between 2001 and 2002, total revenues for the company
after market entry, the BB division generated ¥4.6 billion,
increased 87.6 percent. Equally impressive has been the
or about 52 percent of the company’s total sale, and almost
tremendous revenue growth for both Yahoo! Auctions (362.7
doubled the ¥2.7 billion raised by Yahoo! Japan’s traditional
percent) and Yahoo! BB (67.4 percent). Revenue growth in
core online advertising business segment.
Yahoo! Japan’s other services (62.5 percent) also suggest that
Impressive revenue figures, however, are not the main
the strategic digital distribution channel of broadband may
reason for the Company’s entry into broadband service. By
have had synergistic effects for all of Yahoo! Japan’s business
stimulating aggregate broadband penetration and enhancing
units. Although the company’s initial success in diversification
the digital distribution network of Internet-enabled comput-
offers no guarantees for the future, Yahoo! Japan has placed
ers, Yahoo! Japan is increasing demand for its other services
itself in an excellent position for sustainable growth into the
(listing, portals, auctions), and making access to these services
future.
much easier and faster.
In addition to current Yahoo! Japan services, the Company DISCUSSION QUESTIONS
has great hope for Voice-over-IP (VoIP) service as a future
1. What future concerns should Yahoo! Japan have as the
revenue stream. VoIP utilizes Internet connections to conduct
company’s diversification strategy continues to grow?
voice conversations, providing tremendous savings from exist-
ing phone charges. For VoIP to work, however, broadband 2. Will Yahoo! Japan be able to continue its extraordinary
connections capable of handling real-time voice transmissions revenue growth into the future?
and encoding and decoding are required. Yahoo! Japan seeks 3. How essential is Yahoo! BB to the future of the company?
to increase broadband penetration until services such as VoIP 4. How should Yahoo! Japan manage the relationships with
become viable options for the company. Softbank and Yahoo! Inc. in the future?
704 • Case 15 • AOL Goes Far East
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 15
AOL GOES FAR EAST
On an uncharacteristically warm day in Tokyo in December
1999, John Barber, a managing director of AOL Japan, absent-
mindedly glanced out the widow focusing on the sunlight
gleaming off a nearby skyscraper. This was his third market-
ing meeting today, and he had the same sinking feeling about
this one that he had had about the other two and the hundreds
before them. Like 90 percent of the other material that came
from the marketing department, this one would flop. The local
marketing staff was just not up to speed, and a great deal of
resources were being wasted on this exercise in futility.
John had been in his current position since AOL Japan was
established in 1997, and he was starting to get impatient. The
company was not too far off on its subscription targets, and
the company was inching toward profitability. However, John
was not satisfied. John felt that the company was not living
up to the potential that one would expect of a joint venture
between the largest Internet provider in the world and one of
Japan’s largest companies.
Some critics complained that AOL entered the Japanese
market too late. When AOL Japan started service in April
of 1997, Niftyserve and BigGlobe already had a large stable
of dedicated users. However, John dismissed this as a major
factor in the current difficulties. After all, when AOL Inc.
registered its first online subscriber, CompuServe had been in
business for more than 18 years. Whatever the case, John was
determined to find a way to catapult the company into the
leading Internet service provider (ISP) position in Japan.
THE PARENT: AMERICA ONLINE INC.
America Online Inc. had a modest beginning. Founded in 1985
as Quantum computers, the company began by offering online
services for Commodore Business Machines. By the time the
World Wide Web came along almost 12 years later, AOL was
well positioned to take advantage of it. The company grew
at a steady pace for most of its history, but within the past
two years, its revenue shot skyward as if gravity had suddenly
dissolved. The company grew internally as well as acquir-
ing many promising businesses. Exhibit 1 shows some of the
major units of AOL Inc. in 1999. The company also acquired
MapQuest in 2000, an online provider of travel information
and road directions.
In January 2001, the parent company finalized the acqui-
sition of a large portion of the assets of Time Warner, on
what was touted to be one of the most significant mergers
of the decade. However, almost two years later, the merged
company is facing several problems and declining earnings.
Finances
In 1999, the last year before AOL began its merger with
Time Warner, 69 percent of total revenue came from the
This case was prepared by Bill Baker, Steven Engen, and Trevor Nelson of
Temple University Japan and revised by Sonia Ketkar of Temple Univer-
sity under the supervision of Professor Masaaki Kotabe for class discussion
rather than to illustrate either effective or ineffective management of a
situation described (2003).
20 million paying subscribers to the AOL and CompuServe
services. Due to the dangers of relying heavily on subscription
fees in such a competitive market, the company had clearly
stated that it intended to move away from subscriptions and
rely more heavily on advertising. Therefore, it was not a
surprise that the fastest growing segment of revenue came
from the ‘‘advertising, commerce, and other’’ category. This
category included online advertising fees, sales of merchan-
dise, as well as other revenues. In 1999, the ‘‘advertising,
commerce, and other’’ segment accounted for 21 percent of
total revenue as compared to 14 percent of total revenue in
1997. The Enterprise Solutions generated revenue from licens-
ing fees, technical support, consulting, and training services.
This segment continued to decrease in importance. In 1997,
this segment provided 16.9 percent of total revenue, and this
figure declined to 10 percent in 1999. The financial information
shows that 1999 was AOL’s best year ever. Exhibit 2 presents
operating income and net income from 1997 to date as well
as the cash held in 1999 (before the merger). Since then, the
company has merged with Time Warner, and after repeatedly
revising its financial outlook in the lower direction, in 2002
reported that its earnings would not be as high as expected.
International Expansion
AOL’s 1999 Annual Report stated: ‘‘The Company’s interna-
tional strategy is to provide consumers with local services in
key international markets featuring local language, content,
marketing, and community.’’ AOL started its international
expansion in Germany almost five years ago. Since that time,
the company has expanded into Australia, Brazil, Canada,
France, Japan, the UK, Sweden, and Hong Kong. Jack Davies,
vice president of international operations, led the expansion.
All the joint ventures have been undertaken with a partner
in the local market. In Germany, AOL chose Bertelsmann
AG (multimedia company) and in Latin America, they joined
with Cisneros (media, entertainment and telecommunications
company). However, in Japan, AOL chose Mitsui & Company,
one of Japan’s largest and oldest general trading companies.
Mitsui & Company
Mitsui & Company was founded in 1941. It was originally
part of the Mitsui Zaibatsu that was broken up after the end
of World War II. Mitsui has more than 11,000 employees in
60 countries and in 1998 had capital of US$1.9B. Mitsui is
known as one of the most traditional trading companies in
Japan. Exhibit 3 shows a list of the company’s most familiar
products. Like most ‘‘general’’ trading companies in Japan,
Mitsui’s real strength is in facilitating large transactions for
commodity-type products. Their core competency, if any, is in
import, export, and financing.
Mitsui has all the connections and money required to suc-
ceed in the Japanese ‘‘general products’’ market, but it had
very little experience with the Internet, especially in 1995
when the discussions with AOL began.
 Case 15 • AOL Goes Far East • 705

EXHIBIT 1
AOL DIVISIONS
Type of Acquired or
Business Unit Type of Business Members Access Developed

AOL Internet online 19,000,000 Subscription Developed

service
CompuServe Internet online 2,000,000 Subscription Acquired
service
Netscape Internet portal 17,000,000 Free Acquired
Netcenter
AOL Instant Web-based 25,000,000 Free Developed
Messenger communication
service
ICQ Web-based 50,000,000 Free Acquired
communication
service
Digital City Local online 4,300,000 core Free Partnership
content
provider
AOL MovieFone Movie guide and 150,000,000 Free Acquired
hits in 1998 ticketing service
Spinner Networks Internet music 2,000,000 core Free Acquired Source: America Online
provider Inc., 1999 Annual
Report.

EXHIBIT 2
FINANCIAL PERFORMANCE
Operating Income Net Income
600 600
550 550
500 500
450 450
400 400
US$ (millions)

US$ (millions)

350 350
300 300
250 250
200 200
150 150
100 100
50 50
0 0
1997 1998 1999 1997 1998 1999
Source: America Online Inc., 1999 Annual Report

OVERVIEW: INTERNET IN JAPAN
Japan, though catching up, is still lagging behind the United
States in terms of connectivity. There are an estimated 46
million households in Japan, of which 33 percent (15 mil-
lion) have a PC. In addition, only 18 percent of households
(8 million) are connected online. Nevertheless, the number of
online households is expected to grow significantly, fueled by a
number of factors. First, the number of PC shipments domes-
tically reached 10 million by 2000 (a 12-percent increase from
1999). This would mark the third straight year of double-digit
PC growth. In addition, there are clear trends toward lower
connection costs for end users. The high cost of connecting to
the Internet has been recognized as a primary barrier restrict-
ing the percentage of Japanese going online. Lower access
charges are expected to reduce this barrier and to get more
consumers connected.
There are five primary ISPs in Japan fighting for market
share. The largest is Niftyserve (19 percent), followed by
Biglobe (7 percent), DTI (7 percent), AOL Japan (3 percent),
and Compuserve (1 percent). A plethora of small to midsize
ISP companies comprise the remaining 63 percent market
share.
706 • Case 15 • AOL Goes Far East
EXHIBIT 3
SAMPLE OF MITSUI PRODUCT PORTFOLIO
Iron and Steel Energy
Nonferrous Metals Foods
Property Development Textiles
Machinery General Merchandise
Electronics Chemicals Source: Mitsui & Company, Website:
http://www.mitsui.co.jp/tkabz/english/iandpp/index.htm
AOL JAPAN
AOL Japan was established in February 1996 and rolled out
its services on April 15, 1997, amid much excitement, as peo-
ple familiar with the ‘‘AOL success story’’ in the United
States held high expectations for AOL’s entry into the sec-
ond largest economy. Wired Magazine hailed AOL’s entry
into Japan, stating ‘‘AOL’s Japanese service is certain to
cause waves in a nation unaccustomed to competitive pricing
for Net access.’’ In an interview at this time, Jack Davies,
then AOL’s president of new market development stated,
‘‘Our focus is going to be in the consumer market. We think
that is going to be the major growth area in the Japanese
market over the next five years.’’ Indeed, AOL had hopes
that its Japan operations would become its second-largest
subscriber base.
Setting up the Business
AOL decided on a joint-venture collaboration with local part-
ners as its entry into the Japan market. AOL Japan was
established as a joint venture between AOL (50 percent),
Mitsui & Company (40 percent) and Nihon Keizai Shinbun
(‘‘Nikkei’’) (10 percent). According to AOL management, the
of collaboration with two well-established Japanese compa-
nies was an essential component of their strategy and they
‘‘wouldn’t think about going into a major international mar-
ket without partners.’’ AOL’s relationship with Mitsui dated
back to the early 1990s, at which time Mitsui USA began
researching Internet service providers and was attracted by
AOL’s potential. Mitsui USA research on AOL eventually
led to meetings with AOL in 1994 to explore entering into the
Japanese online service market. In late 1995, Mitsui and AOL
agreed on the structure of the joint venture. Mitsui believed it
was crucial to have fresh, Japanese content provided to con-
sumers and therefore introduced Nikkei to AOL, who later
agreed on Nikkei becoming a partner in the business. At the
onset, Nikkei and Mitsui provided the necessary capital and
invested a combined $50 million to get the Japanese business
up and operational. For its part, AOL provided value to the
collaboration in the form of its technology, know-how, and
brand name.
With the aim of increasing the number of subscribers to
its service, AOL displayed an interest in entering strategic
alliances with other companies. NTT DoCoMo bought a 42
percent equity stake in AOL Japan at the end of the year 2000
for around $100 million. The company hoped that this alliance
with Japan’s leading mobile phone carrier would give it access
to NTT DoCoMo’s huge and ever-growing customer base.
Going one step further, AOL Japan was renamed DoCoMo
AOL after just over three months of the alliance. Thus, as of
the end of 2001, DoCoMo owned 42.3 percent in AOL Japan,
AOL owned 40.3 percent, while Mitsui held 13.2 percent and
Nihon Keizai Shimbun a 4.2 percent stake.
Management Structure
The Board of Directors of AOL Japan is comprised of seven
people, including three non-Japanese people from the U.S.
AOL operations. Only one of these non-Japanese board
members, John Barber, resides in Japan and participates in
day-to-day operations. The current president of AOL Japan
is Kozuo Hiramatsu, who joined the company in July 1999
after serving eight years as president of IDG Corporation.
The following five groups report to the president:
• Member Services
• General Affairs
• Marketing
• Content
• Technology
Recruiting responsibilities have rested almost entirely with
Mitsui. This includes the hiring of top management, although
AOL has the ultimate power to approve or reject the nomina-
tion. Initially, AOL Japan was staffed almost primarily with
Mitsui employees. In 1997, the company had 120 employees.
This number grew to 230 in 1999.
Management Difficulties
Almost four years after launching its services in Japan, AOL
Japan has clearly not succeeded in meeting initial expecta-
tions. The subscriber base, though growing steadily each year,
only totals approximately 400,000, a number that is dwarfed
by Niftyserve’s subscriber base of over 2.5 million. In the
four years since its inception, AOL Japan has experienced
a number of difficulties with management. It was concluded
that the first two presidents, selected by Mitsui, were unable
to take AOL Japan to the next level. After two such failures,
AOL decided that it would be responsible for searching and
hiring the next president. After a long search, the company
hired Kozuo. Hiramatsu, who tried to convince insiders and
outsiders alike that he had the ‘‘right stuff.’’ Following its
alliance with NTT DoCoMo, the company appointed NTT’s
Minoru Nakamura as the president of the company. By doing
so, the company hopes that it will be able to fully tap the
benefits of its latest partnership with NTT DoCoMo.
According to John Barber, the difficulty lies in finding top
local people with the necessary managing experience and the
essential marketing savvy to compete in the world of ‘‘Inter-
net time.’’ Finding such a person has become somewhat like
finding the ‘‘holy grail,’’ according to Barber. The problem is
that, in Japan, most managers do not reach their position until

after the age of 40. This would not be a problem, except that
most people over 40 lack the leadership and vision necessary
to run an Internet ISP.
AOL has not helped this situation by placing only one non-
Japanese AOL person on the ground in Japan. Many of the
challenges facing the Japanese corporation are similar to those
faced by the U.S. business. One has to believe that AOL Japan
would benefit by more ‘‘experienced’’ AOL non-Japanese par-
ticipating in the daily operations and management of AOL
Japan.
MARKETING ORGANIZATION AT AOL JAPAN
Since its entry into the Japanese market, staffing for the mar-
keting organization in Japan has been the responsibility of the
Mitsui team. Mitsui hired all local employees in the marketing
department. The marketing organization is one of the five
groups that report directly to the president of AOL Japan.
The marketing organization is also responsible for the MIS
system used to drive their marketing decisions.
The marketing strategy initially employed was based on
the strategy that was successful for AOL in the United States.
The marketing group in Japan, however, does try its own
strategies in addition to those recommended from the United
States.
The initial and primary strategy consisted of four main
approaches to capturing market share in Japan. The first is
referred to as bundling; the second is the use of magazine
inserts; the third is the use of direct mail solicitations; and the
fourth is ‘‘Take-ones.’’
Bundling. Bundling is the process by which a PC maker
includes AOL software preinstalled on each PC. In this case,
when the customer boots the machine, the AOL icon is visible
on the desktop. The customer also receives AOL documenta-
tion in the box. AOL usually has an offer of X free hours at
no risk to the customer for trial usage. If the customer decides
that he wants to join AOL, he can easily do so just by clicking
the AOL icon on the desktop.
Another method of bundling is to have an agreement with
the OS manufacturer—in this case Microsoft. By bundling
with Microsoft, AOL can ensure that it has a copy of its soft-
ware on each PC—whether or not AOL has an agreement
with the PC manufacturer. The only issue associated with the
installation in the OS is that it is buried within a folder in
the operating system files, so it is not easily accessible to the
casual user.
Bundling in the United States has been very successful for
America Online. This promotion was responsible for over 30
percent of the users in the United States (somewhere around 6
million customers). U.S. manufacturers such as Compaq, Dell,
and Gateway as well as many smaller manufacturers initially
were not interested in the ISP business, so the relationship
with AOL was symbiotic with the PC manufacturer because
Internet access was an application that drove the customer to
upgrade its PCs. The consumer received some benefit from
having the ISP sign-up form easily accessible from the desktop.
In addition, the PC manufacturers received some commission
based on the number of customers that signed up for the
service.
AOL Japan has also used bundling as the primary mech-
anism for signing up new users. It has been able to sign
Case 15 • AOL Goes Far East • 707
contracts with 12 to 15 PC manufacturers in Japan (including
U.S. manufacturers active in the Japanese market). The PC
manufacturers in Japan, unlike U.S. manufacturers, are much
more active in the ISP business. Fujitsu, which is one of the top
three PC makers in Japan, also owns the largest ISP in Japan,
Niftyserve. NEC, the largest PC manufacturer in Japan, also
owns an ISP. The ISP is BigGlobe, and it is the second largest
ISP in Japan after Niftyserve. Sony also owns Soo-net, an
ISP in Japan. The relationship between the ISPs and the PC
manufacturers in Japan is more complicated than that in the
United States because the PC manufacturers tend to be ISP
providers as well.
After its partnership with DoCoMo, AOL Japan also
planned to promote the use of its service via the Internet
accessible i-mode cellular phone system.
Magazine Inserts. Another successful marketing technique
for AOL in America is the use of magazine inserts to deliver
the AOL software via CD inserted into the magazine. One
way of doing this was to shrinkwrap each magazine with a
CD placed within the shrinkwrap. Another, but more expen-
sive, technique is to have the CD actually attached to a page
within the magazine itself. The magazine insert techniques
were responsible for initial enrollment of about 30 percent
(around 6M users) of AOL U.S. customers.
AOL Japan’s results with magazine inserts have been
disappointing. For one reason, the magazine companies, in
general, have been tough to do business with. In addition, the
shrinkwrapping of magazines is not as prevalent in Japan as
in the United States. AOL Japan has been able to do some
magazine inserts, but it has also gone a step further in a
couple of marketing promotions. AOL Japan has created its
own magazine, which is issued when there is a major software
upgrade. It is sold on the newsstands like a normal magazine.
Overall, however, the customer hit rate per yen for magazine
insert promotions has been lower than the results obtained via
bundling.
Direct Mail. Direct mail has also been responsible for ini-
tial sign-up of about 30 percent of the U.S. AOL customers.
However, in Japan, this approach has not been particularly
successful. According to John Barber, there are two fun-
damental issues: (1) the lack of available mailing lists that
accurately pinpoint the desired customer base; and (2) the
fact that mailing costs are much more expensive in Japan than
in the United States. The combination of these two points
causes the number of new subscribers/yen to be much lower
for direct mail marketing in Japan than in the United States.
Take-Ones. Another marketing technique for finding new
subscribers is called Take-ones. In this technique, the AOL
software CD is prepackaged in a small, thin package and is
then put on display in places where potential customers might
congregate. One natural place is computer stores, such as
SoftMap, where one can find a stack of AOL Take-ones next
to the cash register. The customer sees the Take-one, and if he
is interested in connecting to the Web, then he will ‘‘take one’’
home. According to John Barber, the Take-ones have been
reasonably successful in Japan. The hit rate for Take-ones is
much higher than direct mail or magazine inserts because if
someone takes one home, they have a much higher level of
708 • Case 16 • Danone: Marketing the Glacier the United States
interest in signing up to an ISP than the reader of a magazine or
someone who receives an unsolicited mail offer. In addition,
AOL Japan usually combines the Take-ones with another
promotion—such as Pokemon or a movie, like Tarzan—to
increase the hit rate of the Take-ones. The cross promotion
with Pokemon had one unexpected drawback: parents of the
children swamped the AOL User Support Line with orders
for Pokemon cards!
Moving Forward
AOL Japan’s share of the Japan market is now about
3 percent. It has grown over the past three years from 0
to the current 3 percent, while other ISPs have been relatively
flat. In addition, AOL Japan has been capturing between 10
and 15 percent of the new subscribers to the Internet in Japan
over the past two years. Although other ISPs might be satisfied
with this progress, AOL has about a 50 percent market share
in the United States and will not be happy with such a small
share of the market in Japan.
According to John Barber, AOL Japan looks at three
different ways to grow their market share:
• Increase marketing efficiency—if AOL Japan can lower the
amount of yen it takes to capture a subscriber, then it can
capture a higher percentage of new users to the Internet.
• Take advantage of watershed events—as technology
changes the nature of the Internet or creates new ways
to the Internet, opportunities will arise to capture new users
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 16
DANONE: MARKETING THE GLACIER IN THE UNITED STATES
INTRODUCTION
As a former windsurfing champion and current CEO of
France’s Group Danone (Danone), Franck Riboud has lit-
erally and figuratively ‘‘ridden the waves’’ to success. His
Group Danone, which he has led as CEO since 1996, is the
number seven food and beverage company in the world. With
a refocus on its core businesses, dairy products, beverages,
and biscuits, as well as a divestiture of its sprawling nonrelated
entities, the company’s stock price nearly doubled during his
five-year tenure ($16.1 in December 1997 to $26.2 in Decem-
ber 2002, with the high of $31.0 in January 2001). Much of this
success is attributed to Riboud, whose casual, laid-back style
has transformed into a forward-thinking, profit-focused strat-
egy for Danone. With $14.5 billion in net sales and $1.5 billion
in after-tax profits, the company has experienced positive sales
growth rates under his leadership.
Delivering 27 percent of the firm’s global sales, Danone’s
water products, led by the well-known glacier-source Evian
This case was prepared by Michael Pendleton and Aaron Tennant of the
Fox School of Business and Management at Temple University under
the supervision of Professor Masaaki Kotabe for class discussion rather
than to illustrate either effective or ineffective management of a situation
described (2003).
through support of these technologies. If AOL anticipates
these changes better than other ISPs, then it will have the
opportunity to capture more market share. One example
is Internet access via mobile phones. In less then one year,
NTT DoCoMo, with its T-Mode Internet access service via
the displays on portable phones, went from 0 to 3 million
subscribers, despite the fact that the services via the portable
phone are very limited.
• Buy other ISPs—there are many thousands of ISPs in
Japan. Many of them are very small and are potential
takeover candidates.
DISCUSSION QUESTIONS
1. Was Mitsui the best partner for AOL to enter the Japanese
market? If so, why? If not, who (or what kind of company)
would make a better partner? Why?
2. Do you think the current joint-venture structure should
continue into the foreseeable future?
3. What structural impediments did AOL face in the Japanese
market that did not exist in the U.S. market? What actions
should AOL take to overcome these obstacles?
4. Make specific recommendations as to what you think AOL
should do to capture additional market share in each of the
three areas mentioned: lower the cost of ¥/new subscriber;
capitalize on watershed events; buy other ISPs.
5. Now that AOL has partnered with NTT DoCoMo, will it
be successful in Japan, or is it too late?
brand, is number two worldwide in packaged water sales.
Although declining in recent years (see Exhibit 1), sales
growth from Danone’s Water Division in the last five years
has been positive.
With all of Danone’s success, Riboud still faced the chal-
lenge of achieving a more even geographic distribution of its
customer base, particularly in the United States. The questions
posed to him by investors and his board were—How could a
giant like Danone only derive 11 percent of its sales from the
United States? What opportunities is Danone missing by not
being the major bottle water player in the United States?
‘‘DIVERSIFICATION: Reduce Danone’s dependence on
Europe, which accounts for 76 percent of sales. Derive 33 per-
cent of sales outside the Continent by 2000.’’ This was one of the
three major strategic plans that Riboud wanted to implement
during his tenure—and it would prove to be the most difficult.
On the whole, a whopping 57 percent of the company’s sales
derived from Europe, and only 11 percent came from the
United States (see Exhibit 2).
After taking away the successful Dannon yogurt line and
focusing on water sales in the United States, it was clear
that Danone’s presence was even more of a failure. By the
end of 2001, Pepsi’s Aquafina and Coke’s Dasani had over-
taken Danone in volume of water sold in the United States
 Case 16 • Danone: Marketing the Glacier the United States
to become the number two and three players, respectively,
behind Nestlé’s Perrier and Poland Springs brands. Danone is
now number four in the United States after having the number
one brand in the country as recently as 1996, and its market
share has plunged in the U.S. bottled water market.
EXHIBIT 1
SALES GROWTH FOR DANONE’S
WATER DIVISION
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1998 1999 2000 2001 2002
EXHIBIT 2
DANONE SALES BY REGION, 2001
USA
France 11%
23%
Rest of Europe
34%
Rest of world
32%
What Danone had failed to realize was that selling bot-
tled water was completely different in the United States than
selling it in Europe. Danone has maintained a stronghold in
Europe by mastering its complicated direct-to-store delivery
systems and taking advantage of an educated consumer base
that willingly accepts Evian’s premium price and relies less
on drinking tap water. Contrarily, success in the U.S. water
market means access to a giant colarun distribution network
that includes access to rented store shelves.
When it came to water and the success of Danone’s water
sales in the United States, the company was struggling. But as
recently as the beginning of 2002, Riboud made strong state-
ments refuting the need for Danone to be successful in the
U.S. water market. ‘‘The Danone business equation is not a
U.S. equation, it’s Asia, Latin America, Europe. Water in the
United States represents just two percent of our global sales
volumes . . . we have no reason to have an inferiority complex.
Our strategy lies elsewhere.’’ These strong statements were
contrary to the ‘‘DIVERSIFICATION’’ strategy that Riboud
had planned to implement during his tenure. These statements
would also prove to be contrary to Riboud’s aggressive moves
in its U.S. water operations, made within days of his bold
statement.
In the first of two dramatic agreements with one of its
primary competitors, Coca-Cola, Danone announced in April
2002 that the cola giant would take over management of the
Evian brand in North America. According to analysts at J.P.
Morgan, under this agreement Coca-Cola will have master
• 709
distribution rights to Evian and will handle all promotional
and customer marketing, in-store merchandising, bottler sales,
and food service sales. Danone will still manage sourcing and
retain control of Evian’s brand image and advertising strategy.
The agreement includes incentives for Coke’s efforts to
boost demand, based on a target of 5 percent to 10 percent
annual sales growth. This is estimated to translate into a
potential return of $8.5 to $17 million annually, given that
Evian accounted for about 22 percent of Danone’s U.S. water
sales of approximately $780 million in 2001. If the incentives
produced an average increase in sales of $12 million, it would
represent an increase of less than 1 percent of total sales for
Danone.
Danone’s second major agreement came in June 2002,
when Danone and Coca-Cola announced a joint venture for
the production, marketing, and distribution of Danone’s local
and regional branded retail bottled spring and sourced water
from within the United States. (For example, Danone’s Dan-
non brand spring water is sourced in the United States.) The
terms of the complex agreement are as follows:
• Danone contributes the assets of its retail bottled spring
and source water business in the United States, including
five production facilities, a license for the use of the Dannon
and Sparkletts brands, as well as ownership of several value
brands.
• Coca-Cola pays Danone $128 million cash for a 51 percent
ownership interest and will provide marketing, distribution,
and brand management. Most importantly, the agreement
contains volume and profit guarantees from Coca-Cola
requiring sales volume to grow in line with the large brands
in the market (currently 20 percent annually) to maintain a
stable market share while achieving a guaranteed level of
profitability. However, it is unclear what penalty Coca-Cola
will face if it fails to secure this level of growth. According to
J.P. Morgan, the amount of volume involved is 135 million
cases, and they estimate that revenues for the joint venture
could be in the $200 million dollar range.
Quick to defend his statements of unconcern for the U.S.
market just a few months prior, Riboud rationalized, ‘‘the mar-
ket is totally different from five years ago . . . the agreement
with Coca-Cola will help us find a strong growth pattern
again.’’ Wall Street analysts have debated whether these
moves represent an alliance that will translate into growth
for Danone and Evian, or whether these agreements mark
Danone’s unofficial withdrawal from the U.S. bottled water
market.
Certainly, the Coke joint venture, though completed,
remained an uncertain guarantee in Evian’s gain for market
share in the United States. Thus, many questions remained
for Riboud to ponder. How does a CEO disclaim the need
for the U.S. market and then complete a mega-deal in the
same market a few months later? Will the joint venture with
Coke assure success for Danone and Evian? Was this deal
a desperate move—could Danone have invested in a U.S.
market strategy on its own? How does a CEO deal with the
rumors of future mergers with U.S. food giants, such as Kraft,
to create a truly global food services company? For Riboud,
the biggest waves were yet to come.
710 • Case 16 • Danone: Marketing the Glacier the United States
DANONE: A BRIEF HISTORY
Group Danone today has very little in common with its orig-
inal operations, except that the Riboud family has been in
charge for over four decades. Danone’s humble beginnings
can be traced back to Lyon, France, where the original firm
was a glass container manufacturer named Souchon-Neuvesel.
Danone’s history reflects three common themes: the company
achievement of a leadership position in its markets, the firm’s
(or the Riboud family’s) willingness to exit successful busi-
nesses in order to redefine itself in the pursuit of growth,
and the company’s successful use of strategic mergers and
acquisitions to perpetuate growth.
• 1965: Antoine Riboud replaced his uncle as chairman of
the family-run Souchon-Neuvesel, a maker of glass bottles
based in Lyon, France.
• 1966: Souchon-Neuvesel merged with Glaces de Boussois, a
major French plate glass manufacturer (windows for build-
ings and autos), creating BSN. The companies came to
together for two primary goals: (1) to cope with the changing
market trend toward ‘‘no-deposit, no-return’’ bottles, and
(2) to create a company that would be large and competitive
enough for the expanding European Common Market.
• End of 1960s: Using acquisitions, by the end of the 1960s
BSN had become one of the largest glass manufacturers in
all of Europe. However, the container industry was chang-
ing as the demand for paper and plastic containers was
spelling doom for glass bottle makers. BSN recognized this
threat and because it did not have operations or ties in
the petrochemicals, forestry, or steel industries, the com-
pany believed a good solution would be to start making the
contents for its containers. This strategy marked another
redefining moment for the company, and once again it
would use acquisitions to create scale and generate growth.
• 1970: BSN took control of Evian, Kronenbourg, and the
European Breweries Company and became the leading
French manufacturer of beer and mineral waters.
• 1973: BSN and Gervais Danone merged companies and
created the biggest food group in France. For BSN, the
merger represented a major opportunity to move forward
and enter new markets, with a decisive shift toward food
products.
• 1980: With escalating energy costs hitting the glass-making
business hard and convinced growth would not return to
this business for some time, BSN Gervais Danone began to
exit from plate glass manufacturing, which did not fit in with
the food side of its business. It pulled out of the plate glass
sector completely in 1981, selling off Boussois and focused
firmly on food from then on.
• 1980s: In a series of acquisitions, BSN began a conquest
of Europe by taking over many local companies in vari-
ous food categories to become Europe’s third-biggest food
group.
• 1982: BSN purchased Dannon, the leading U.S. yogurt
maker (co-founded by Gervais Danone’s Daniel Carasso).
• 1986: BSN entered the biscuit industry by buying General
Biscuit.
• 1989: BSN added to its portfolio of biscuit brands by acquir-
ing Nabisco’s European subsidiaries.
• 1988: BSN began an aggressive push into the global market
with over 40 acquisitions in Asia, Latin America, Central
Europe, Africa, and the Middle East.
• 1994: The company changed its name to Group Danone,
symbolized by a little boy gazing up at a star, to take advan-
tage of the success of its leading brand, which was famous
the world over.
• 1996: Franck Riboud succeeded his father as chairman and
restructured the company to focus on three core businesses:
dairy, beverages (specifically water), and biscuits.
• 1999: Group Danone sold off its container business and
breweries.
DANONE’S BOTTLED WATER BUSINESS
In 2001, Danone’s water division became number one in the
world water market based on volume sales, with 12.5 percent
of the global market. As a portion of total firm revenues, bot-
tled water comprised 27 percent, or approximately $3.4 billion
of total revenues for Danone in 2001. Danone has accom-
plished its leadership position by using a two-tier strategy:
first by extending Evian as a global brand and then by using
acquisitions to acquire top regional and local brands. Danone
reports its company financials using the broad segment clas-
sifications of France, Rest of Europe, and Rest of the World.
A look at Danone’s water sales by region for 2001 was: 64
percent Rest of the World, 19 percent Rest of Europe, and 17
percent France.
Clearly, Danone is a favorite in its home country and in
Europe, where Danone has enjoyed continued growth through
innovation. The firm has experienced high growth in Europe
with flavored waters and has even introduced diet waters in
France and Italy. European growth has even been derived
from offering certain sized containers and enviro-friendly
containers that easily collapse to encourage popular recycling
campaigns. Danone has not introduced these innovative prod-
ucts in the U.S. water market. However, the company has built
a very strong presence globally, where it is typically ranked
among the top three companies in the countries in which it
operates. Danone’s leadership position in water sales in var-
ious countries is illustrated in Exhibit 3. Although the data
from the table show how successful Danone’s water opera-
tions are globally, the U.S. market clearly stands out as one of
disappointing performance.
Evian: Danone’s Glacier Brand
Driving Danone’s global water sales is the successful exten-
sion of Evian as a global brand. Evian is the number two
water brand in the world by volume, and it is shipped to over
120 countries on five continents each day. Evian distinguishes
itself as pristine, natural spring water, bottled at one source,
Cachat Spring in Evian-Les-Bains, France. The magnificent
French and Swiss Alps converge around the Mont Blanc,
which towers above the lakeside town of Evian-Les-Bains.
The spring waters from Cachat Springs are world renowned,
and Evian-Les-Bain is famous in Europe for its spa resorts.
Untouched by Man. Perfect by Nature is a trademark of
Evian Natural Spring Water, and it is used to imply unique
 Case 16 • Danone: Marketing the Glacier the United States
EXHIBIT 3
DANONE’S WATER SALES AND MARKET POSITION
Water Sales by Region Water Position by Country
France
17% France
Spain
Italy
U.S.
Rest of Europe Canada
19% Mexico
Argentina
Rest of World China
64% Indonesia
pristine water. Accordingly it is priced at a premium. Evian
Natural Spring Water begins as rain and snow falling high
in the French Alps. It is said that the water then spends at
least 15 years slowly filtering down through a vast, protected
aquifer deep within the mountains. This wonder of nature as it
is known was created by nature over several millennia through
the advance and retreat of the Rhone Glacier, which ground
loose boulders into an ultra-fine sand. As the water passes
through this purifying filter and over mineral-rich rock, the
water is insulated from all external contamination by dense
layers of protective clay and emerges at Cachat Spring from
a tunnel in the mountains at 52.88◦ F. Bottled and sealed at
its source as Evian Natural Spring Water, the water is not
artificially altered in any way. Evian Natural Spring Water has
a unique history as is shown below.
30,000 B.C. Aquifer in the French Alps through
which Evian travels formed.
1789 The Marquis de Lessert discovers the
Cachat Spring.
1826 The Duke of Savoy grants authorization
to bottle Evian.
1878 The French Academy of Medicine rec-
ommends that the Ministry of Health
renew the bottling authorization for the
water.
1906 Responding to a water shortage caused
by the great San Francisco earthquake
and fire, Evian is donated to support
relief efforts.
1960 Sold exclusively in pharmacies until
1960.
1970 Evian brand is acquired by Danone.
Evian is presently ranked fourth in the U.S. bottled market
behind Nestlé, Pepsi’s Aquafina, and Coke’s Dasani. Prior to
the entry of the cola giants into the U.S. bottled water market,
Evian enjoyed a number one ranking as recently as 1996. In
the past five years, Evian’s U.S. market share has been halved
from 7.2 percent to 3.6 percent.
THE U.S. BOTTLED WATER MARKET
Beginning in the 1980s, bottled water has become the beverage
of choice for a more healthy fitness-oriented society. Vending
machines stocking water and soft drinks are normally first
emptied of their water supply, even if a water fountain is
• 711
Local Ranking
No. 2
No. 1
No. 3
No. 4
No. 2
No. 1
No. 1
No. 1
No. 1
nearby. Aside from the fitness attributes of bottled water,
consumers are also drawn to the purity that bottled water
provides. During the 1990s, the amount of water sold in the
United States has increased from two billion gallons in 1990
to 5 billion in 1999 (see Exhibit 4).
Molecularly speaking, water is a compound consisting of
two atoms of hydrogen and one of oxygen. From a marketing
standpoint, however, water represents the largest opportunity
in the consumer beverage market. A free resource, covering
nearly 75 percent of the world, is now marketed as a premium
to an ever-increasing health conscious society. Perhaps a back-
to-basics approach is necessary to explain the phenomenon
that is bottled water.
Water is classified as ‘‘bottled water’’ if it meets all appli-
cable federal and state standards, is sealed in a sanitary
container, and is sold for human consumption (see http://www.
bottledwater.org/public/BWFactsHome main.htm). There
are several different varieties of bottled water. The Food
and Drug Administration’s (www.fda.org) product definitions
for bottled water are as follows.
• Well Water: Bottled water from a well that taps a confined
aquifer in which the water level stands at some height above
the top of the aquifer.
• Mineral Water: Bottled water containing not less than 250
parts per million total dissolved solids may be labeled as
mineral water. Mineral water is distinguished from other
types of bottled water by its constant level and relative
proportions of mineral and trace elements at the point of
emergence from the source.
• Purified Water: Water that has been produced by distillation,
deionization, reverse osmosis, or other suitable processes.
(Both Pepsi’s Aquafina and Coke’s Dasani are purified
waters.)
• Sparkling Water: Water that after treatment and possible
replacement with carbon dioxide contains the same amount
of carbon dioxide that it had at emergence from the source.
(Nestlé’s Perrier brand would be considered a sparkling
water.)
• Spring Water: Bottled water derived from an underground
formation from which water flows naturally to the surface of
the earth. Spring water must be collected only at the spring
or through a borehole tapping the underground formation
finding the spring. (Evian is spring water.)
712 • Case 16 • Danone: Marketing the Glacier the United States
EXHIBIT 4
BOTTLED WATER CONSUMPTION IN THE UNITED STATES
6000
5000
4000
3000
2000
1000
0 1.04
1990 1991 1992 1993 1994 1995 1996
Millions of gallons Millions of dollars Price per gallon
Bottled water trade organizations, manufacturers, and
(more recently) consumers concur that the two favoring
differences of bottled water over tap water are consistent
quality and taste. The belief (with varying degrees of substan-
tiated proof) is that bottled water is consistent because it is
inspected and monitored by governmental and private labo-
ratories. Although bottled water does indeed originate from
protected sources (75 percent from underground aquifers and
springs) and tap water comes mostly from rivers and lakes, it is
the guaranteed consistency of taste that has drawn consumers
to plucking down a dollar or more for a bottle of water (even
if that drinking water fountain is a few steps away).
The classifications of bottled water have had little impact
on the U.S. consumer. In fact, the result of these classifica-
tions has created a murky bottled water market in which little
distinction is made in the advantages of one type of bottled
water over another. For Evian, this customer indifference has
been a substantial disadvantage in gaining market share in
the United States. The additional handling and transportation
costs of bottling from one glacier source in the French/Swiss
Alps force Danone to market Evian at a premium price.
Evian’s average cost per case is about 80 percent higher than
that of Aquafina or Dasani. In the United States, customers
place little value on this premium and simply choose the
less expensive bottled water. In Europe, consumers are more
knowledgeable about the types of bottled water and accept
the premium on the Evian brand.
Competing Products in the U.S. Market
The primary bottled water competitors in the U.S. market are:
Perrier and Poland Springs (Nestlé). Nestlé has
formidable midrange and high-end bottled water
brands in the United States with Perrier and Poland
Springs. Perrier has been imported into the United
States since the turn of the twentieth century. It was
first bottled in 1863 and is available in more than
100 countries. Every bottle of Perrier sold around the
world is bottled at the source in Vergeze, France. Per-
rier is the best-selling imported sparkling water in the
United States. The source of Poland Springs water is
1.13
1.12
1.11
1.10
1.09
1.08
1.07
1.06
1.05
1997 1998 1999
located in a pine forest and is protected by 350 acres
of preserved land in rural Maine. Poland Spring is a
leading brand of bottled water in America, benefiting
from Nestlé’s formidable distribution network onto
U.S. supermarket shelves.
Aquafina (PepsiCo). Aquafina is also created from
tap water, though the company is hesitant to use
the description ‘‘local water supply’’ on its Web-
site. ‘‘Aquafina uses state-of-the-art purification sys-
tems, including reverse osmosis and carbon filtra-
tion. These processes are what allow us to guar-
antee Aquafina’s consistent purity and great taste.’’
(www.aquafina. com)
Dasani (Coca-Cola). ‘‘To create Dasani, Coca-Cola bot-
tlers start with the local water supply, which is then
filtered for purity using a state-of-the-art process called
reverse osmosis. The purified water is then enhanced
with a special blend of minerals for a pure, fresh taste.’’
(www.dasani.com)
OPTIONS FOR MARKETING EVIAN IN THE UNITED
STATES
Unlike most bottled water markets in the world, the U.S.
market poses unique competitive pressures for Danone and
its Evian brand. It is evident that the firm never saw the
cola giants’ entry into the bottled water market coming, or if
they had done so, they must have underestimated the impact
to their market share and long-term sales growth. Danone’s
recent agreements with Coke may be too little, too late to
preserve Danone’s presence as a top-selling firm in the U.S.
water market.
Should the alliances with Coke fail, three alternative strate-
gies could be considered for Danone and its Evian U.S. water
operations.
Go It Alone. For Evian to go at it alone in the U.S. market
would mean that Danone would have to accept the
brand as a niche product rather than a leading product
in the U.S. water market. Leadership in the U.S. bot-
tled water market that is being determined by price
and logistics alone locks Evian into being priced at

a premium and therefore not competitive for market
share. By marketing Evian’s unique pristine quali-
ties, and positioning the brand as a niche, high-end
premium beverage with a ‘healthy’ edge, Evian may
be able to provide Danone a higher-margin product,
albeit with smaller volumes.
A second part to Danone’s U.S. water market strat-
egy would be to position its Dannon spring water, a
locally sourced spring water, to compete against Nestlé
and the colas for market share in the high-volume,
price-driven retail market. However, the Dannon
line’s production and distribution would have to be
built out with acquisitions. The strategy to go it alone
would require high investment from Danone, and
the return on that investment would be very long in
coming.
Get out of the U.S. Market. Another option presented
to Franck Riboud is to leave the United States alto-
gether, keeping the Evian brand in the United States
only as a niche player. Perhaps management needs
to realize that water drinkers in the United States
with their lack of differentiation among bottled water
varieties, are not within the scope of Danone’s global
marketing strategies. Because the marketing successes
that Evian has experienced in other countries cannot
translate to the U.S. market, a no-entry strategy would
eliminate costly entry expenditures and allow Danone
to shift focus to gaining share in countries where the
‘‘glacier premium’’ is recognized. This option could
be referred to as the ‘‘LU Biscuit strategy’’—while
Danone’s biscuit brand is number two in the world, it
is nonexistent in the United States.
Merger/Acquisition. Among the possible acquisition suit-
ors for Danone, including Nestlé, Unilever, and even
the cola giants, Kraft Foods appears to be the company
best positioned to capitalize on the merged syner-
gies. Kraft is the largest branded food and beverage
company in North America and the second largest
worldwide, based on 2001 revenues (Nestlé is num-
ber one). Kraft’s brands are sold in more than 145
countries. According to AC Nielsen statistics, they
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C ASE 17
BMW MARKETING INNOVATION
Since the competition started to imitate BMW’s advertising
messages of outstanding quality, BMW decided to come up
with a unique way of reaching its target audience. The com-
pany did so by hiring Fallon Worldwide, an advertisement
agency based in Minneapolis, Minnesota, to come up with a
new campaign. Fallon developed the concept of ‘‘The Hire’’
This case was prepared by Martin Hellhake, Fabian Henault, and Josh
Jacob of Temple University under the supervision of Professor Masaaki
Kotabe for class discussion rather than to illustrate either effective or
ineffective management of a situation described (2002).
Case 17 • BMW Marketing Innovation • 713
are found in more than 99 percent of all households
in the United States. Nearly three times the size of
Danone, Kraft derives 70 percent of its revenues from
North America and has an extensive brand portfo-
lio that includes a variety of food products except
for bottled water. Acquiring Danone would allow for
entry into the growing bottled water market, as well
as increase the consumer base into Europe and Asia.
One of Kraft’s core strategic goals is to increase its
global economies of scale and expand its brands geo-
graphically. Acquiring Danone would be in alignment
with this strategy—its 90 percent revenue base out-
side of the United States and owner of the number two
water brand in the world could make a Kraft/Danone
combination a true synergy fit.
Perhaps one of the most important factors stopping an
acquisition of Danone is company’s nationalistic, historical,
and family pride. Franck Riboud’s family, his allegiance to
his French culture, and his sense of individual ownership of
the Danone brands are formidable blockades to allowing the
company to be acquired.
Riboud contemplates Danone’s U.S. bottled water market
strategy as he windsurfs the calm waters of Lake Geneva. He
muses, ‘‘Five years from now, could the decision I will make
be the subject of numerous business school case studies as
the correct way to maintain market presence in the U.S. or a
wrong way?’’ Of course, only time will tell.
DISCUSSION QUESTIONS
1. Why has Evian’s U.S. market share continually decreased
since the emergence of the cola giants’ bottled water brands
in the late 1990s?
2. In evaluating Danone’s strategy for gaining U.S. market
share, present the positives and negatives for remaining a
single-enterprise entity and ‘‘going it alone.’’
3. Given Evian’s lack of success in the U.S. market, what
would be the ramifications of Danone’s’ existing the U.S.
bottled water market altogether?
4. Are the joint ventures with Coca-Cola the right decision?
Why or why not?
series. Fallon’s responsibility also included the way in which
these movies were to be delivered to BMW’s target audience.
It was also questionable whether the campaign should be the
same throughout the world, or if it should be localized to
adapt to language and consumer taste differences. In order
to attract highly recognized directors, as well as actors, BMW
was willing to spend a large amount of money.
In addition to coming up with a unique advertising cam-
paign, BMW also wanted to change its image. One of the goals
was to make BMW look not only cool, but likeable, which
714 • Case 17 • BMW Marketing Innovation
the brand needs to do to combat negative perceptions some
people have based on old associations with the 1980s style
yuppie arrogance.
COMPANY PROFILE
BMW (Bayerische Motoren Werke Aktiengesellschaft) was
founded in 1916 and has been publicly traded since 1969. The
company produces, and markets, a varied range of higher end
sporty cars and motorcycles. BMW has also manufactured the
first passenger car running on hydrogen ready for common
use, although the production figures are limited by the lack of
a respective filling station net. In addition to cars and motor-
cycles, BMW operates an aircraft engine division under the
brand name of Rolls Royce.
The company has worldwide subsidiaries and manufactur-
ing plants in Germany, Austria, the UK, the United States,
Mexico, Brazil, South Africa, Egypt, Thailand, Malaysia,
Indonesia, the Philippines, and Vietnam. The company also
operates its own financing company, which offers financing
for vehicles. Automobiles accounted for 78 percent of 2000
revenues; vehicle finance leasing, 18 percent; motorcycles,
3 percent; and other, 1 percent (see Exhibit 1).
EXHIBIT 1
BMW’S REVENUE SOURCES
2000 Revenue
80%
70%
60%
50%
40%
30%
20%
10%
0%
Auto Motor- Finance Other
cycles leasing
MARKETING OVERVIEW
The majority of BMW’s success is attributed to the devel-
opment of a consistent marketing policy, the market niche
strategy. The company has built its brand on four core values:
• Technology
• Quality
• Performance
• Exclusivity
BMW has maintained these core values since the com-
pany’s inception. Coupled with WCRS (BMW’s advertising
agency since 1979), the company has adopted a consistent
advertising strategy. In addition to the message of these val-
ues being portrayed in advertising campaigns, the company
explicitly expresses one or more of these values in all BMW
advertisements. However, it is important to point out that
BMW also relies on its sensitivity to the environment, which
is clearly seen by how the company’s advertisements evolved
in response to economic, environmental, and competitive
changes.
This design philosophy, which runs through every BMW,
has been communicated through a number of TV and print
ads. The brand image has been built up by using over 300
color press advertisements and, more recently, through a total
of 64 different television commercials. Throughout this cam-
paign, BMW has remained true to its beliefs in focusing on
the substance of the cars themselves.
In addition to the high-profile national color press and
television advertising, individual dealers are encouraged to
run their own local campaigns. Local press, radio, and bus
advertisements are all available from BMW dealer marketing.
In addition, brochures, price lists, and dealership point-of-sale
materials are made accessible through the corporate office.
BMW encourages its dealers to make use of these services.
Providing the dealers with a central source for advertising,
BMW ensures that all communications remain standardized
as well as maintaining BMW’s brand values.
BMW has embarked on a global advertising campaign.
What differentiates this promotion is the fact that it remains
consistent throughout the company’s international campaign
across the European, U.S., Asian, South African, and Middle
Eastern markets. In over 15 countries there will be:
• TV spots
• Print advertisements
• Mega-posters
• Radio spots
• Events
In all three James Bond films, BMW, MGM, and EON Pro-
ductions Ltd. worked together on a cross-promotion project.
This was accomplished worldwide with TV commercials and
print ads, as well as displays in BMW dealer showrooms.
BMW FILM
The best new film series, by the most cutting-edge directors,
are not playing at the local theater. Instead, these films are
accessible through your home computer as well as your local
BMW dealership.
Since its launch at BMWFilms.com, ‘‘The Hire’’ (a film
series consisting of five different short films) has been singled
out as the first high-profile, big-budget, celebrity-laden Inter-
net marriage of advertising and entertainment. It has been
reviewed, scrutinized, deconstructed, and cited as evidence
of the perilous future for traditional advertising. New York
Times film critic Elvis Mitchell called the series ‘‘a marriage
of commerce and creativity, straddling the ever-dwindling line
between arts and merchandising.’’ BMWFilms is simply the
latest and possibly the hippest Website to make use of stream-
ing video in order to lure prospective customers. Fast cars,
mysterious passengers, Buddhist monks, rock superstars, and
sinister enemies are all part of the film series, which are pre-
sented in installments by some of Hollywood’s top directors.
These films are being advertised on television the same way
that movie trailers are advertised; the difference is that instead
of the catch-phrase ‘‘Coming soon to a theater near you,’’ this
catch phrase reads ‘‘See it only on BMWFilms.com.’’
Actor Clive Owen (star of the acclaimed British film
Croupier and, in the opinion of his growing legion of fans,

the next James Bond) is ‘‘The Hire’’ in the series title, a
skilled mercenary driver who seems to specialize in risky
assignments. While he is certainly a smooth operator behind
the wheel (very ‘‘James Bond’’ like), it is always the Ultimate
Driving Machine that saves the day. The car is definitely the
star of the show.
Each episode features a ‘‘driver’’ (in a BMW, naturally)
who is on a mysterious nighttime mission along with a mysteri-
ous passenger. Examples include one incident where the driver
is on the run with a small Buddhist boy and another episode
that has an arrogant superstar diva (played by Madonna)
desperately wanting to escape the swarm of the paparazzi.
Filmgoers, thrill seekers, and potential customers have the
option of watching the video using Real Video or Quick-
Time video players. Another option is to download the BMW
Film Player, a fairly simple process offered through the BMW
Website, which turns the computer screen into a miniature
personal theater complete with ‘‘DVD quality’’ pictures and
sound. Installing this player allows the user to download and
view the video on the full computer screen while offline. In
addition to the full-length videos, BMW also offers trailers
for those customers with slower modem connections. These
trailers allow viewers to have a ‘‘quick peek’’ at the films.
The numbers of viewers to the site are soaring each week.
One week following the advertising blitz of the Website films,
traffic to the site was up 55 percent to 214,000 unique visitors
compared to only 138,000 the previous week (according to the
Web measurement firm Nielsen/Net Ratings). This tremen-
dous leap made BMWFilms one of the Internet’s fastest
growing sites.
The films all have differentiating styles, but they all hold
one thing in common: the majority of the action takes place in
a BMW while the participants are in the middle of a car chase.
There is no limit to the actual number of BMWs that you will
see; one, two, three, even more Beemers are seen speeding
down alleyways and streets, screeching around corners.
BMW did not randomly decide to initiate a Web-based
advertising campaign. The company clearly did its homework.
It is well known among advertising firms that over 85 per-
cent of potential car buyers will conduct most (if not all) of
their initial research on the Internet before they make a final
decision on a purchase. Therefore, BMW has made it con-
venient for shoppers by adding a link to their film site from
BMWUSA.com. This site gives consumers basic information
about the car(s) as well as the location and phone number of
the local dealerships.
Given that the average BMW automobile starts at approx-
imately $30,000, the company’s decision to design a classy
film series, which can be viewed on a high-speed Internet
connection by an upscale, mostly male audience, is clearly
targeted.
The simple concept of these films—BMW wants to sell
cars!
Film Concept
In the spring of 2000, two factors were on the table at BMW.
The first was concern over TV effectiveness, and the sec-
ond was how to exploit the popularity of the Internet. BMW
wanted to come up with an entirely new branding campaign;
too many competitors were copying the ‘‘look and feel’’ of the
BMW, and the company needed to do something different to
Case 17 • BMW Marketing Innovation • 715
distinguish itself. On a more basic level, BMW was growing
more concerned about its ability to reach its core market via
traditional methods such as network TV.
The creative team of writer David Carter and art director
Joe Sweet had recently completed a project for Timex with
director Tim Burton. This marketing campaign incorporated
an Internet portion that featured short videos specifically shot
for the Web.
The executives at BMW saw this as a way to differenti-
ate the company from other manufacturers. BMW wanted
something done exclusively for the Internet, something not
only entertaining but also cinematic. A concept was born—a
longer film that would be shot in segments and distributed
via the Internet as a series. This series would combine prod-
uct placement with entertainment. Most importantly, it would
allow BMW to push the envelope when it came to scripting the
series. The Internet would allow the company to show what a
BMW can do when pushed to the limits, under extreme con-
ditions and circumstances. BMW would not be able to convey
this type of advertising through traditional TV ads, without a
few hundred disclaimers.
BMWFilms has accomplished several objectives; the most
important being the tremendous buzz in both the enter-
tainment and business press. This was important to BMW,
since one of its goals was to make the BMW look cool,
without the old association with the 1980s style of yuppie
arrogance.
A fact that was not prominently mentioned in much of the
coverage of ‘‘The Hire’’ was that the core creative concept,
along with key strategic thinking, Web development, and sev-
eral scripts, all came from one source: Publicis Troupe’s Fallon
Worldwide in Minneapolis. ‘‘I think we’re reinventing adver-
tising,’’ said David Lubars, Fallon president and executive
creative director. Lubars added: ‘‘We’re not looking to make
this a template, as though this is what advertising is [going to
be]. I think what technology affords you is that every client
can get their own customized media approach, and this was
really right for this client.’’
‘‘BMWFilms.com is a good example of blurring the
lines between entertainment and advertising,’’ said Jarvis
Mak, senior Internet analyst at NetRatings. ‘‘The site com-
bines Hollywood’s intense car chase scenes and Internet
video to deliver a new spin on product showcasing,’’ added
Mak.
‘‘We think that a lot of the time when people view tradi-
tional advertising they view it through a filter of disbelief,’’
said Jim McDowell, vice president of marketing for BMW
of North America. ‘‘When people watch entertainment or a
movie, then they’re watching in an entirely different way where
they enjoy the fantasy, and hopefully remember it and share it
with others.’’ ‘‘We thought maybe instead of doing advertising
we should be doing entertainment and doing something fun
and interesting on the Web,’’ McDowell said.
What if you do not have a computer, or if your computer is
not hooked to a T1 connection? Never fear, BMW has already
begun buying infomercial time on the Bravo and Speedvision
channels to showcase their ‘‘Hire’’ series.
Target Audience
Initially, BMW had no real idea as to whom the films would
appeal. BMW executives knew they would have everyone
716 • Case 17 • BMW Marketing Innovation
from high school students to 7-Series owners as viewers.
BMW’s guess was that their central tendency would be
25-year-olds with a median income of $100,000. BMW and
Fallon research indicated that many were tech-savvy and had
fast, reliable access to the Web. Most important, 85 percent of
buyers had researched the vehicle on the Web before stepping
into a showroom.
Characteristics of the Typical BMW Target Audience
Societal values are changing rapidly. Society will increasingly
take its cue from Generation X’ers and dot.comers rather than
the baby boomers who have dominated its thinking for most
of four decades. Associated with that demographic shift will
be a return to the appreciation of self-reliance and cooper-
ation—self-reliance because the traditional safety platforms
such as Social Security and pensions will no longer exist, and
cooperation because it involves group action that, in turn, is
the optimal strategy for the use of scarce resources. Family
issues such as long-term health care, day care, and antidrug
campaigns will remain dominant issues until the end of the
decade.
Generation X and dot.com will have major effects in the
future. This 30-something Generation X cohort will be rec-
ognized for its entrepreneurial instinct since its members are
starting businesses at unprecedented rates. They are econom-
ically conservative, begin saving at an earlier age, and seek
the shallow information skimmed from CNN or USA Today
rather than absorb in-depth reporting.
Members of the dot.com generation, now entering their
20s, are proving to be even more business-oriented. Twice
as many say they would prefer to own a business rather
than be a top executive. By a factor of 5 to 1, they would
rather own a business than hold a key position in politics or
government.
In summary, the corporate and business culture of the
baby boomers is a mismatch for these advancing generations
that thrive on challenge and opportunity. It is more than
cash that they want. They understand the need for lifelong
learning because that is the way life has always been for
them. In addition, as both customers and employees, they
will demand even more advanced telecommunications and
net-based transactions. Consumerism is still growing rapidly.
Because consumers will increasingly have access to and infor-
mation about pricing, services, delivery time, and customer
satisfaction through the Internet, the consumer marketing
battle will see a halt in the decline of prices and a counterpre-
vailing shift to service improvement and salesmanship.
In the end, however, fixed pricing will fall out of favor as
goods and services are sold through online auctioning. The
proponents of the need for improved customer service will
be proved right. To quote the report, ‘‘As prices fall to com-
modity levels and online stores can list virtually every product
and brand in their industry without significant overhead, ser-
vice is the only field left in which marketers can compete
effectively.’’
Lorraine Ketch, the director of planning in charge of Levi’s
trendy Silvertab line explained, ‘‘This audience hates market-
ing that’s in your face. It eyeballs it a mile away, chews it up,
and spits it out.’’
As expected, branded items with dominant reputations will
remain powerful and in demand.
MARKETING CHANNELS
Internet
Auto manufacturers have taken some innovative approaches
to draw Internet users to their Websites. However, it is sur-
prising how quickly innovative becomes ordinary. Slide shows,
flash animation, and surround video are now commonplace on
most manufacturer’s sites. In addition, contests have become
so common that the possibility of winning a free car may not
be enough to hold a viewer for more than a few minutes.
Ad banners 468 × 60 in size are sold on a run-of-site (ROS)
basis, meaning that they will appear on every search results
page and on an equal rotating basis with other advertisers’
banners. Advertising rates for 468 × 60 ad banners are com-
puted on a cost-per-thousand (CPM) impression basis and are
currently priced at US$10 to $15 CPM. Flashing banners and
other methods cost slightly more based on the Website and
technology involved.
For online ads, each advertiser is given password-protected
access to real-time advertising statistics, including how many
impressions were served, how many click-throughs were
achieved, and what click-through rate was achieved. The
industry standard for the click-through rate is anywhere from
0.25 percent to 2 percent, for sites like CNN, ZDNet, or
Yahoo. Your actual click-through rate will depend on the
appearance of your ad and on what it offers in terms of a
marketing message and call to action. Just like running a tele-
vision commercial during prime time, or placing a full-page
ad in Time magazine, these ads do not necessarily cause peo-
ple to pick up the phone and order a product at that very
moment, whereas a Web-based process that guides the con-
sumer through a systematic process makes a purchase more
likely. Specifically, these types of ads build name recognition
for the company and establish it as a major force in the indus-
try. Then, when consumers are ready to buy, your company
will come to mind.
Television
The 1999 American Association of Advertising Agencies
Commercial Production Costs Survey revealed that the aver-
age cost of a 30-second national commercial for an automobile
was a whopping $389,000. The percentages of viewers of
MSNBC and Bravo who are in BMW’s target income bracket
constitute 20.5 percent. The percentage of viewers in BMW’s
target age group (25–34) is 26.5 percent.
Print
The advertising rates in a periodical like Time magazine range
from $250,000 for a full-page mono to $360,000 for a full-page
color ad. The average age of a Time magazine subscriber is 45,
and readers have a median income of $69,000. This audience
is twice the age and has half the income of BMW’s intended
target market. Time magazine is one of the premier periodicals
on the market at this time.
DVD Promotions/Freebies
The cost of producing a DVD master is between $50,000 and
$100,000—plus the cost of producing any bonus materials.
DVD player penetration in the United States today is approx-
imately at 25,600,000 units. This trend is supposed to increase,
and the DVD is projected to become the next VHS.
 Case 18 • Herman Miller, Inc. vs. ASAL GmbH • 717

COMPETITIVE ANALYSIS IS 300, roughly 75 percent male, between the ages of 35 and 40,
married, highly educated, with annual household incomes of
In 1997, BMW was in danger of losing its long-standing lead
$100,000. The current average age of a Lexus owner is 50, with
in the import luxury car segment. Mercedes, Lexus, and Audi
the median age of the brand’s hottest selling vehicle, the RX
were coming on strong, with great new products and new mar-
300 sport-utility, at 48. The estimated $32 million campaign
keting campaigns designed to dethrone BMW. Nearly half of
for the car broke recently on national TV and will continue
those considering a luxury car rank ‘‘fun to drive’’ as their
for the next six months. Team One, El Segundo, California,
number one reason for purchasing the car. However, for the
created the two national TV commercials as well as five TV
first time since BMW had been tracking its image, consumers
spots for regional dealer ad groups and two magazine ads. The
ranked BMW at virtually the same level as Mercedes or Lexus
agency also created billboards and six commercials that will
on attributes like ‘‘fun to drive’’ and ‘‘responsive handling.’’
be projected on buildings in three cities.
BMW’s three biggest competitors had launched new adver-
Their online presence even for this campaign is limited,
tising campaigns that highlighted what traditionally had been
though Lexus is one of the advertisers launching a rich-media
BMW’s greatest strength: performance. Therefore, BMW was
campaign on the Excite Network, which includes WebCrawler
not able to distinguish itself anymore as the only company
and Classifieds 2000.
that boasted the unparalleled standard of quality as before.
Audi
Mercedes
Audi is an international developer and manufacturer of high-
The range of cars from the giant company DaimlerChrysler
quality cars. In 2000, the company sold more than 650,000
traditionally rival BMW’s. In 2000, DaimlerChrysler sold
Audi models. The sales revenues of the Audi Group totaled
1,155,000 units and had revenues of 43.7 billion euro. Mer-
39 billion Deutsche marks. The Audi Group has slowly but
cedes’ strengths would be its global presence, strong brand
surely been encroaching on the BMW and Mercedes markets.
presence, product range, and technology leadership. Mer-
It has been trying to promote the exclusivity of its cars.
cedes’ marketing campaigns have always been subdued and
Recently, Audi of America has embarked on its most ambi-
low key. It allocates 25 percent of its annual marketing bud-
tious online marketing effort ever. The European car importer
get to innovative Internet strategies, recognizing the power
kicked off the ‘‘Double Take’’ ‘‘advertainment’’ online sweep-
of the Internet for delivering effective and precise market-
stakes as part of its $25 million launch of the redesigned 2002
ing campaigns. When the car manufacturer launched the new
A4 sedan. Visitors to the site can try to solve mysteries after
Mercedes C Class Sports Coupe, it positioned the online
viewing clues from three short episodes involving the A4.
campaign right at the top of its marketing mix. Joining in
They can also register to win prizes while learning about the
a winning partnership with MSN, another global brand with
car and its features. The grand prize is a three-day trip for two
similar values, Mercedes sponsored A-Ha’s eagerly awaited
to the Audi Driving Experience at the Panoz Driving School
homecoming concert.
in Atlanta, Georgia. The sweepstakes, run by Don Jagoda
Lexus Associates, Melville, New York, allows prospects to enter up
to eight times. ‘‘The main thing is to educate and entice users
Sparked by a decision from Toyota chairman Eiji Toyoda in
to go to dealerships,’’ said Steve Glauberman, president-CEO
1983 to challenge the best luxury vehicles, Lexus has since
of Enlighten, the privately held Ann Arbor, Michigan, creator
grown into one of the world’s most inspiring automobile com-
of the site and sweepstakes.
panies. Lexus is a division of Toyota Motor Sales, U.S.A., Inc.
It is trying to leverage the Japanese technology to add brand DISCUSSION QUESTIONS
value to its vehicle. Lexus is America’s top-selling luxury mar-
1. Should BMW be using a uniform global promotion strat-
quee. The tough task for Lexus is to lose the ‘‘Cheap But
egy?
Reliable’’ Toyota image. The annual sales of Toyota vehicles
in the United States have been on the order of $90 to $93 2. Should BMW show its new marketing campaign on the
million in recent years. Internet exclusively, or should it be part of the media mix?
According to Chris Conrad, Lexus’ national advertising 3. What are the implications of marketing for dot.comers and
manager, Lexus is targeting its youngest buyers ever with the Generation X’ers?

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 18

HERMAN MILLER, INC. VS. ASAL GMBH

In early May 1999, Vreni Sahli, international sales man-
ager for office furniture manufacturer Herman Miller, Inc.
(www.hermanmiller.com), received a call from John Paul
Fournier, manager of Herman Miller Ltd.’s German oper-
ation. According to Ms. Sahli, Mr. Fournier ‘‘informed me
that they had become aware of a company by the name of
ASAL showing and selling chairs, Aeron chairs, in the Ger-
man market.’’ The Aeron chair, one of Herman Miller’s
most successful new product lines with ‘‘a patent list as
long as your arm’’ (www.hermanmillered.com/catalog/), is
718 • Case 18 • Herman Miller, Inc. vs. ASAL GmbH
a unique, trademarked product nominated ‘‘Design of the
Decade’’ by Business Week magazine. Fournier’s concern
stemmed from complaints from Herman Miller’s authorized
dealers/distributors who were surprised to find an established
German firm, ASAL GmbH, selling Herman Miller Aeron
chairs and keyboard trays at the INTERZUN International
Trade Fair in Köln, Germany. Herman Miller had an estab-
lished distribution system in Europe consisting of 100 or
so authorized dealers/distributors with exclusive territories.
ASAL GmbH was not one of them. Authorized Herman
Miller dealers/distributors complained that ASAL GmbH was
selling Aeron chairs for less money than they could buy them
for! Keiro, a Herman Miller, Ltd. dealer in Europe called
Herman Miller to ‘‘say they have exclusive rights; (ASAL)
can only sell chairs at list price as per HMI.’’
Despite Herman Miller’s corporate policies that prohibit
authorized dealers/distributors from selling directly to over-
seas clients outside their assigned territory, Fournier told
Vreni Sahli that ASAL GmbH was acquiring the chairs
through a Florida company. As international sales manager,
Sahli reported directly to the VP of International Sales and
Distribution. She did not typically get involved with exclu-
sively U.S. dealers. However, within days, she was on the
phone with Jack Howard, general manager of Herman Miller
Florida, Inc. and president of Office Pavilion South Florida,
Inc. Herman Miller Florida was Herman Miller’s subsidiary
in Florida, and Office Pavilion South Florida was a company-
owned dealer. ‘‘Jack did confirm for me that there was a
document that had been signed by Office Pavilion in Miami
with ASAL [Products Inc., a Florida corporation] with the
intent to distribute keyboard trays for particular manufactur-
ing environments in the German market through a company
over there.’’
Vreni Sahli faced one of the toughest decisions of her
17-year career at Herman Miller. By entering into a contract
with Florida-based ASAL Products to sell Aeron chairs and
keyboard trays for export to Germany, Herman Miller’s sub-
sidiary in Florida had created a parallel channel of distribution.
What could or should she do about this ‘‘gray marketing’’ that
was disrupting Herman Miller’s authorized channels of dis-
tribution? She immediately called the corporate counsel, Jim
Christiansen, for advice.
BACKGROUND INFORMATION
Herman Miller, Inc. Herman Miller, Inc. is an office furniture
manufacturer headquartered in Zeeland, Michigan. Its office
furniture products include chairs, keyboard trays, desks, draft-
ing tables, and stools. Herman Miller had sales of $1.7 billion
in 1998, $1.8 billion in 1999, and $1.9 billion in 2000. Exhibit 1
provides three years of consolidated operating results for
Herman Miller.
Herman Miller has an international distribution system
consisting of ‘‘wholly-owned subsidiaries and they in turn,
This case was developed by Michael R. Mullen, C. M. Sashi, and Patricia
M. Doney of Florida Atlantic University as a basis for evaluating theory
versus practice and to facilitate classroom discussion rather than to illus-
trate the effective or ineffective handling of an administrative situation
(2003). It was adapted from their ‘‘Gray Markets: Threats or Opportunity?:
The Case of Herman Miller vs. Asal GMBH,’’ in Tiger Li and Tamer S.
Cavusgil, eds., Advances in International Marketing (Greenwich, CT: JAI
Press, 2003) with permission from Tiger Li & Tamer S. Cavusgil.
either sell on a direct basis or through distribution in specific
geographies.’’ Herman Miller’s European subsidiary, Her-
man Miller Ltd., is headquartered in Bath, England. In 1999,
Herman Miller Ltd. had contracts with about 100 distribu-
tors in Europe. In the U.S. market, Herman Miller also uses
subsidiaries (e.g., Herman Miller Florida, Inc.) and company-
owned distributorships (e.g., Office Pavilion South Florida,
Inc). In addition, there are independent distributors and deal-
ers in Florida and elsewhere in the United States. According
to Sahli, ‘‘A distributor is basically a retailer who covers a
particular area from a sales standpoint and from a service
standpoint. Very different from what we do as a corporation,
which is at corporate level.’’
ASAL GmbH and ASAL Products, Inc. ASAL GmbH is
a 60-year-old German firm in the office furniture business,
among others. ASAL GmbH had more than 100 employees at
three locations in the EU and was owned 99 percent by its pres-
ident, Barnard Stier. ASAL GmbH had sales of DM35,000,000
in 19961 and has current sales of DM37,000,000.
In 1996, an ambitious young German named Oliver Asel
took a job with ASAL GmbH (no relation; hereinafter
referred to as Oliver for simplicity). After two years, Oliver
decided to seek greener pastures in America. In the United
States Oliver took a job with office furniture distributor, Office
Pavilion South Florida, Inc. At Office Pavilion he became
knowledgeable about Herman Miller’s line of office furniture,
including pricing for products such as the Aeron chair and
keyboard trays.
In 1998, Oliver moved back to Germany for personal rea-
sons, returning to work for ASAL GmbH as sales manager.
At that time, the EU was implementing new harmonized
office health standards covering issues such as distance to the
computer monitor and appropriate seating. Oliver believed
that Herman Miller keyboard trays combined with the Aeron
chairs were an excellent solution to the new EU health stan-
dards. According to www.hmeurope.com, ‘‘The Aeron chair
sets new standards for comfortable and health-promoting
office seating . . . [it] meets and exceeds major international
standards.’’ Oliver convinced Stier that ASAL GmbH should
pursue these product lines.
In September 1998, Oliver contacted Jean-Paul Fournier,
German manager for Herman Miller Ltd. on behalf of ASAL
GmbH. He was quoted DM229.5 for delivery of 1000 key-
board trays. On September 30, 1998, the exchange rate was
1.6696 DM/$, so the quote was $137.46/tray. According to
commercial Websites, Aeron Chairs were being sold in the
EU in small quantities for approximately DM1800 to DM2000
during May 1999. Using a May 12, 1999, exchange rate of
1.8359 DM/$, the prices were $960 to $1200/chair.2 However,
1 On June 10, 1999, Jean-Paul Fournier received a report on the financial
strength of ASAL GmbH. The D&B report showed that ASAL GmbH
had 1996 sales of DM 35,000,000 or about US$20 million. It also showed
that the company financial resources were from 4 to 20 million DM (the
basis is the total wealth), or between $2.2 million and $11.1 million. Those
sales and wealth numbers indicate that ASLA GmbH, while hardly a
start-up company, was still very small relative to Herman Miller.
2
For instance, a price quote in April from Norman Stadler GmbH listed
the chairs at DM1,970 for 5 to 10 units and DM1,760 in lots of 40 to 80, and
Keiro’s Website listed the Aeron chair at DM2,170 each. The exchange
rate at that time was 1.8359 DM/$.
 Case 18 • Herman Miller, Inc. vs. ASAL GmbH • 719

EXHIBIT 1
HERMAN MILLER (CONSOLIDATED RESULTS)a
(FROM www.hermanmiller.com)
Operating Results (In Millions) 2000 1999 1998

Net Sales $1,938.0 $1,766.2 $1,718.6

Gross Margin (3) 732.4 687.4 656.8
Selling, General, and Administrative 425.1 414.7
(3) ”456.4
Design and Research Expense 41.3 38.0 33.8
Operating Income 234.7 224.3 208.3
Income Before Income Taxes 221.8 229.9 209.5
Net Income 139.7 141.8 128.3
Cash Flow from Operating Activities 202.1 205.6 268.7
Depreciation and Amortization 77.1 62.1 50.7
Capital Expenditures 135.7 103.4 73.6
Common Stock Repurchased plus Cash $101.6 $179.7 $215.5
Dividends Paid

Key Ratios
Sales Growth 9.7 2.8 14.9
Gross Margin 37.8 38.9 38.2
Selling, General, and Administrative 23.6 24.1 24.1
Design and Research Expense 2.1 2.1 2.0
Operating Income 12.1 12.7 12.1
Net Income Growth (Decline) (1.5) 10.5 72.5
After-Tax Return on Net Sales 7.2 8.0 7.5
After-Tax Return on Average Assets 16.5 18.5 16.7
a For details, footnotes, and other years, please see
After-Tax Return on Average Equity 55.5 64.4 49.5
the Herman Miller Website.

based on his experience in Florida, Oliver knew that the
same trays and chairs were being sold much cheaper in the
United States. Confronted with the Florida pricing informa-
tion, Fournier told Oliver that if he did not like the prices in
Germany, he should buy office furniture in America.
Oliver then contacted his former boss, Gary Kemp, VP
Operations at Office Pavilion South Florida, to buy trays and
chairs to sell in Germany. Because Herman Miller corpo-
rate policies forbid dealers/distributors from selling directly
to overseas clients outside their assigned territory, Oliver was
told that ‘‘If I wanted to buy keyboard trays from Herman
Miller Office Pavilion, I have to form a U.S. company.’’ As
Jack Howard, the president of Herman Miller Florida and
Office Pavilion explained, ‘‘If we were selling keyboard trays
to ASAL U.S. or a Florida organization, that wouldn’t be in
violation of our [HM corporate] agreement.’’
In December 1998, Stier and Oliver formed a Florida cor-
poration, ASAL Products, Inc. for the purpose of reexporting
products purchased in the United States to ASAL GmbH
in Germany. Stier owned 100 percent of the stock, and the
board was the same as ASAL GmbH: Stier was president
and Oliver was vice president. The new firm was created as a
‘‘pass-through’’ organization to circumvent the internal rules
of Herman Miller, Inc.
Oliver negotiated a two-year purchase contract (January
8, 1999) with Gary Kemp, VP Office Pavilion, for keyboard
trays priced at $76.25 for quantities of less than 2000 units.
These were the same trays Fournier, the German manager
for Herman Miller, quoted at the equivalent of $137.46/tray
for orders of 1000 or more, an 80 percent price differential.
In an April 30, 1999 letter, a German Herman Miller dealer,
Norbert Stadler GmbH, quoted ASAL GmbH DM1970/chair
($1073.04) in quantities of five to ten chairs and DM1760/chair
($958.66) for 40 to 80 chairs. In May 1999, Office Pavilion
South Florida agreed to sell ASAL Products an unlimited
number of Aeron chairs at $511/chair (in lots of 2000 or more)
through the end of 2000, as well as a new model keyboard
tray with palm rest and mouse tray at $173.24. The prices
quoted by Norbert Stadler GmbH were more than 85 percent
higher than the $511 price for nearly identical3 Aeron chairs
in Florida.
Under the contract and its addendums, Office Pavilion
agreed to deliver keyboard trays and chairs to ASAL Prod-
ucts Inc. in Florida with the written understanding that ASAL
Florida would export those products to ASAL Germany. A
contract with a parallel structure was signed between ASAL
Products, Inc. and ASAL GmbH to create the pass-through
organization. Stier felt confident about his new vice presi-
dent Oliver Asel and the parallel channel of distribution they
had created to arbitrage the existing price differentials (see
Exhibit 2.)
3 The only differences in the chairs were the numbering system and a slight
difference (less than an inch) in the height adjustment.
720 • Case 18 • Herman Miller, Inc. vs. ASAL GmbH
EXHIBIT 2
PARALLEL CHANNELS OF DISTRIBUTION
Herman Miller
$ Customers
Headquarters and Factory
$
Herman Miller, Inc. $ Hermann Asal, GmbH
Michigan $ Germany
Office Pavilion
Florida
Asal Products, Inc.
Florida
In 1999, Oliver returned to the United States and opened
an office for ASAL Products in Fort Lauderdale, Florida.
Three or four small orders for trays and chairs were placed
from ASAL GmbH through ASAL Products to Office Pavil-
ion. The orders were paid for, shipped to ASAL Product,
Inc.’s freight forwarder, and exported to ASAL GmbH in
Germany for resale. Everything transpired as agreed upon,
so ASAL GmbH, with Office Pavilion’s knowledge, made
arrangements to attend the INTERZUN, an international
trade fair in Germany, to market these products.
Oliver had already given Office Pavilion a short-term sales
forecast of 5000 to 7000 Aeron chairs and thousands of key-
board trays. With the trade show coming up, Office Pavilion
was abuzz. Everyone from warehouse workers to front office
staff to top executives were discussing the large potential sales
to Oliver and the big impact such sales could have on their
bonuses. At Office Pavilion, salespeople received commis-
sions, and the staff received EVA (Economic Value Added)
bonuses based on year-end performance. Therefore, everyone
at Office Pavilion had personal motivation to increase sales
and profit.
INTERZUN INTERNATIONAL TRADE FAIR, KÖLN,
GERMANY, MAY 7–11, 1999
International trade fairs are far more important in EU mar-
keting in general and in Germany in particular. In preparation
for the show, ASAL mailed letters and postcards to existing
customers, as well as prospective new customers in Germany
EUROPE
Herman Miller
Factory
UK $$
$ Distributors
Prices
$ inflated
60–80% Dealers
and throughout Europe. Office Pavilion employees expedited
sample Aeron chairs and the new keyboard trays for exhi-
bition at the INTERZUN. At the fair, ASAL had a good
location, and Oliver served as the technical representative.
Their reception was much greater than expected. As Oliver
said, ‘‘Chairs were flying out the door—unbelievable.’’ He
also noted that ‘‘I met some gentleman from Herman Miller
International at the trade show.’’
Because of the importance of EU trade fairs, attendance
is audited in a manner analogous to America’s Nielsen rat-
ings. The Audited Trade Fair and Exhibition Figures for the
May 1999 INTERZUN (FKM 2000—see Exhibit 3) showed
audited numbers of 59,343 paid visitors. Eighty-three percent
of those visitors were owners, directors, managers, or staff
with decisive or collective responsibility for purchasing deci-
sions. Although most were primarily small firms with less than
500 employees, 5934 firms had 500 or more employees, and
there were 1187 firms larger than 10,000 employees. Given
the product market (chairs and keyboard trays), number of
employees was a good proxy for potential demand.
On May 12, 1999, immediately after the INTERZUM
trade show, ASAL GmbH sent a written forecast and orders
to ASAL Products, Inc. for 32,320 Aeron chairs and 16,300
keyboard trays valued at over $21.8 million for delivery by
September 1999. The same day, ASAL Products submitted
their first order to Office Pavilion for 2480 Aeron chairs,
accompanied by a check for $633,840 (50 percent deposit).
Office Pavilion VP of Operations Gary Kemp and General
 Case 18 • Herman Miller, Inc. vs. ASAL GmbH • 721

EXHIBIT 3
AUDITED TRADE FAIR AND EXHIBITION FIGURES, REPORT 1999
Total Number of visitors 59,343 Position in the company/organization %
Proportion of trade visitors 98% Entrepreneur, partner, self-employed 36
Region of Residence % Managing director, board members, head 18
Over 100 km away 86 of an authority, etc.
Senior department head, other employee 8
Total Germany 55 with managerial responsibility
Baden-Württemberg 14 Department head, group head 12
Bavaria 12 Other salaried staff 16
Berlin 1 Skilled worker 2
Brandenburg — Lecturer, teacher, scientific assistant 1
Bremen 1 Trainee, student 5
Hamburg 2 Other 3
Hesse 7
Mecklenburg-West Pommerania 1 Area of Responsibility %
Lower Saxony 5 Management 48
North Rhine-Westphalia 43 Research/development/design 9
Rhineland-Palatinate 7 Planning/work preparation 6
Saarland 2 Manufacture/production 13
Saxony 2 Buying/procurement 9
Saxuny-Anhalt 1 Administration/organization/personnel/social 2
Schleswig-Holstein 1 welfare/training
Thuringia 1 Marketing/sales/advertising/PR 9
Other 4

Total Foreign 45 Frequency of visits to trade fair %

EU 59 1997 50
Rest of Europe 13 1995 36
Africa 3 1993 27
Central & South America 5 First visit 42
North America 5
Middle East 7 Size of company/organization
East Asia 4 Number of employees %:
Australia 4 1–9 . . . . . . . . . 30 200–499 . . . . . . . . . 12
10–49 . . . . . . . . . 28 500–999 . . . . . . . . . 4
50–99 . . . . . . . . . 11 1000–9999 . . . . . . . . . 4
100–199 . . . . . . . . . 10 0000-and more . . . . . . . . . 2

Economic Sector % Length of Stay

Industry 45 1. Length of Stay (days) %:
Skilled trades 25 one . . . . . . . . . 57 four . . . . . . . . . 5
Trade 20 two . . . . . . . . . 21 five . . . . . . . . . 5
Self-employed 6 three . . . . . . . . . 12
Other 4 2. Average length of stay = 1.8 days
Share of visitors on the event’s days %:
Influence on purchasing/ % 1st day . . . . . . . . . 30 4th day . . . . . . . . . 40
procurement decisions 2nd day . . . . . . . . . 39 5th day . . . . . . . . . 31
Decisively 56 3rd day . . . . . . . . . 40
Collectively 27
In an advisory capacity 10
No 7
722 • Case 18 • Herman Miller, Inc. vs. ASAL GmbH

EXHIBIT 4 EXHIBIT 5
ASAL’S PROJECTED SALES VOLUME (continued)
(NO. OF UNITS)a
1999 2000 Total
1999 Keyboard Trays Aeron Chairs
Less Operating
May 650 2,480 Expenses 91,373 266,434
June 3750 13,000
Net Profit 3,671,446 3,591,896 $7,263,341
July 5680 13,790
August 6080 2,790
Avg. Sales DM $
September 2780 2,630 Price
October 880 790
November 880 790 Keyboard trays 299.7 $163.24
December 880 790 Aeron chairs 1085.6 $591.32
Fx rate 1.8359 DM/$
1999 sub-totals 21,580 37,060 Wall Street 12-May-99
Journal
2000 Keyboard Trays Aeron Chair

January 880 790

February 880 790
EXHIBIT 6
March 880 790
ASAL GMBH [HM CHAIRS & TRAYS ONLY] PRO
April 880 790
FORMA INCOME STATEMENT
May 880 2820
June 3880 12,790 1999 2000 Totals
July 4880 11,290 Sales Revenue
August 4880 2790 Keyboard trays $5,110,836 5,319,248
September 1780 2630 Aeron chairs 28,765,456 29,378,643
October 880 790
November 880 790 Total HM product sales 33,876,292 34,697,891 68,574,183
December 880 790
Less Cost of Goods
2000 sub-totals 22,460 37,850 Sold
Keyboard trays 3,522,719 3,666,370
a Assumptions: Aeron chairs 21,914,319 22,381,462

1. The International Trade Show in Cologne will yield the same sales in Cost of HM goods sold 25,437,038 26,047,832 51,484,871
2000 as in 1999.
2. The management made large ‘‘house’’ sales of 8,500 chairs in June and Gross margin 8,439,253 8,650,059 17,089,312
July and will do so again in 2000.
Less Operating Expenses
EXHIBIT 5 Sales commission, 2%
ASAL PRODUCTS, INC. PRO FORMA INCOME of sales 677,526 693,958
6 additional employees 114,333 228,667
STATEMENT
Overhead costs of
1999 2000 Total added employees 16,736 33,471
Marketing & Inter-
Sales Revenue national Trade Fair 13,617 103,611
Keyboard trays $3,522,719 3,666,370 Warranty, ASAL
Aeron chairs 21,914,319 22,381,462 GmbH 1.1% 372,639 381,677
Freight, storage &
Total Sales 25,437,038 26,047,832 51,484,871 handling 10% 2,543,704 2,604,783

Less Cost of Net profit 4,700,698 4,603,891 $9,304,589

Goods Sold
Keyboard trays 2,736,560 2,848,153
Aeron chairs 18,937,660 19,341,350
Manager Don Britton agreed to meet Oliver the next day to
Cost of Goods discuss/process the order.
Exhibit 4 shows the total projected sales volume of key-
Sold 21,674,220 22,189,503 43,863,722
board trays and Aeron chairs for the balance of ASAL Product
Gross Margin 3,762,819 3,858,330 7,621,148
 Case 19 • Nova Incorporated: Two Sourcing Opportunities • 723

Inc.’s two-year contract with Herman Miller’s Office Pavilion. Herman Miller, Inc. had to make a strategic decision quickly.
ASAL’s sales projections are based on the actual numbers Office Pavilion’s general manager, Donald Britton, and vice
sold by their salesforce, management’s prior ‘‘in-house’’ sales, president, Gary Kemp waited for a call from Jack Howard
and the outstanding results of the international trade fair. with directions from headquarters.
Exhibit 5 and 6 show pro forma income statements for ASAL
Products, Inc. and ASAL GmbH, respectively, based on those EXHIBIT 7
sales projections. Exhibit 7 shows the exchange rates from the DM/$ EXCHANGE RATES
end of September 1998 to the beginning of June 1999.
Aeron’s DM
The very next day everything changed. Vreni Sahli became
involved, and decisions on what actions to take were elevated Date Fx rate WSJ Cost (@ $590)
to corporate and International Sales and Distribution division September 30, 1998 1.6696 DM/$ 985.06 DM
level. Herman Miller found itself in a difficult predicament.
January 12, 1999 1.6909 DM/$ 997.63 DM
ASAL Products, Inc. had a valid and operating contract to
May 12, 1999 1.8359 DM/$ 1,083.18 DM
buy Aeron chairs and keyboard trays in the United States and
export these products to Europe. Yet there were authorized June 2, 1999 1.8882 DM/$ 1,114.04 DM
distributors and dealers in Europe with exclusive territories.

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 19

NOVA INCORPORATED: TWO SOURCING OPPORTUNITIES

After notifying his management team of their assignments for
the following week’s meeting, Fisher contemplates taking a
short vacation, and, perhaps, reacquainting himself with the
game of golf. As he is preparing to leave, he receives two
memos. The first is from Claudio Spiguel, requesting author-
ity to purchase all products for South America from a local
source. The second is from Wei Chang, the president of the
Asia Pacific region, seeking permission to conduct negotia-
tions that would lead to joint manufacturing and distribution
ventures in India and China. After reading these memos, he
sends copies of them to his management team asking them for
advice and informing them that they should be prepared to
discuss both issues at next week’s meeting.
Copies of Chang’s and Spiguel’s memos follow on pages
628–630.
Based on the financial data from Nova, the results of
pro forma numerical analysis for each of the four alternative
sourcing strategies are provided in Exhibit 1. The numbers
represent expected return on net assets (RONA) at various
points in the company’s sourcing operations. Additional qual-
itative issues that need to be considered are summarized in
Exhibit 2.
DISCUSSION QUESTIONS
1. Evaluate the risks and rewards of internationaliza-
tion/globalization through cooperative strategies via the
opportunities to (1) enter into joint ventures in China and
India in exchange for licenses to NOVA’s process and
product technology and (2) outsource manufacturing in
Brazil.
2. Discuss market orientation in the context of sourcing strate-
gies: ‘‘How do we assure that we provide our customers the
right product/service at the right place, at the right time, at
the right price, at our best total cost?’’
3. Raise some fundamental questions about core competen-
cies and company identity:
• ‘‘Why do we manufacture anything internally?’’
• ‘‘Where is our value-added?’’
• ‘‘How do we capture and share information that will
enable the required communication, coordination, cooper-
ation, and control among value-chain partners?’’

This case was developed by Profs. Jack Muckstadt, School of Operations

Research and Industrial Engineering, Cornell University; David Murray,
Operations and Information Technology, School of Business, College of
William & Mary; Dennis G. Severance, Computers and Information Sys-
tems, The University of Michigan; and K. Scott Swan, Marketing and
International Business, School of Business, College of William & Mary. 
2000 For discussion purposes only: None of this material is to be quoted
or reproduced without the express permission of the authors.
724 • Case 19 • Nova Incorporated: Two Sourcing Opportunities

EXHIBIT 1
NUMERICAL ANALYSIS
(a) Current (c) In-house (d) In-house
In-house (b) Outsource/No Production/ Production/N. American
Production/No change to bonus Transfer price factory payment to S.
change RONA structure RONA change RONA America (Rebate) RONA

Distribution Centers
N. America 14.67% 14.67% 42.52% 14.67%
Euro. Union 11.08 11.08 11.08 11.08
E. Bloc Euro 9.09 9.09 9.09 9.09
S. America 5.24 17.92 17.92 17.92
Asia Pacific 7.38 7.38 7.38 7.38

Factories
Cincinnati, Ohio 12.86 −6.62 −1.49 8.25
London, UK 20.80 20.80 20.80 20.80

Nova Corp
Cincinnati Margin 13.21 8.77 13.40 13.21
N.A. rebate 12.11 −10.32 −3.18 12.11
$734,500
 Case 19 • Nova Incorporated: Two Sourcing Opportunities • 725

EXHIBIT 2
QUALITATIVE ANALYSIS
(a) No change (b) Outsource (c) Transfer price (d) NA rebate

Benefits
Customer Service Doing well but very Similar service Accounting change Accounting change
expensive

Internal Operations Maintain internal Less expensive. Treat as ‘‘short’’ Treat as ‘‘short’’
Frees manufacturing relationship—why relationship—why
capacity for other penalize because penalize because
opportunities. factory in Cincinnati factory in
Less overtime. artifact? Cincinnati artifact?

Innovation, etc. Maintain ability Learning

to innovate and opportunity?
learn

Financial Performance No manipulation of Improve RONA

transfer pricing through transfer
pricing

Risks
Customer Service Quality concerns

Internal Operations Demotivate DC Loss of process and How to deal with No real change.
managers with product secrets. distortion in How to deal with
innovative How to deal with NA DC RONA? Cincinnati factory
solutions? Cincinnati factory No real change RONA?
RONA? How to deal with
Cincinnati factory
RONA?

Innovation, etc. Loss of innovation

& learning?
Improved
adaptability?

Financial Transfer pricing Large RONA

Performance gains lost hit to corporate
726 • Case 19 • Nova Incorporated: Two Sourcing Opportunities

Nova Manufacturing, Inc.

‘‘Your Global Assembly Supplier’’

MEMORANDUM

To: John Fisher, CEO

From: Wei Chang, President, Nova Asia Pacific
Date: June 17, 2000
Subject: Implications for Market Growth Opportunities in the Asia Pacific Region
For the past year you have encouraged me to grow my business substantially. After careful analysis of the opportu-
nities in this region I have concluded that it is possible to dramatically increase sales over the next five years. In fact, I
believe it is likely that we can increase business by a factor of ten. While this may sound optimistic, I am confident that
we can achieve this level of growth.
I have spent several months making contacts in both India and China and have succeeded in establishing appropriate
government and industry ties in both countries. As I toured these countries, I found that there is an enormous requirement
for our products driven by the explosive growth in construction in both countries.
Two reasons make it possible for us to penetrate these markets. First, the local production of widget equivalents is
limited, since the technology for modern widget manufacturing is not known in these places. The outdated production
methods, which are both capital and labor intensive, have made growth in domestic production capacity appear unprof-
itable. Thus, the governments are eager for us to provide our products to them. Second, the quality of the current local
supply is very poor. Where the domestically produced widgets are used, their reliability and durability are a source of
great concern to their users. In fact, numerous accidents have resulted from the poor product design and manufacturing
processes. Our reputation for high quality is therefore a major source of competitive advantage for us.
To date, our major competitors have not succeeded in penetrating these markets, in spite of several concerted
attempts to do so. I suspect that their lack of success so far is due to their failure to appreciate the distinctive cultures
of these countries, and how business must be transacted within them. Nonetheless, our competitors are active and their
products are also well regarded.
For us to compete successfully in these markets, we must have technical support, low prices (much lower than our
current ones), and high quality and reliable supply. Furthermore, it is important to understand the limitations of the
logistics infrastructure in these countries. The major consumers of widgets are not located in places that can be reliably
resupplied from port cities or by air.
I believe that for us to compete, we must undertake joint ventures for manufacturing and distribution in both
countries. The reason for this is twofold: first, to be price competitive we must take advantage of the low labor costs
that are available in both India and China, and we must avoid the tariffs and overheads associated with transporting and
importing products from London or Cincinnati. The second reason that we must have a manufacturing presence is to
gain access to distribution channels. Both governments are looking for technology transfer, and have made it clear that
without licensing our product and process technologies to a locally owned partner, they will be of little help in providing
market access. It would, of course, be folly for us to attempt to build a marketing, sales, and distribution infrastructure
from scratch, and totally on our own. Accordingly, I have begun preliminary discussions with the appropriate government
and industry officials and have identified potential joint venture partners.
I have also gathered preliminary cost data, and estimate that we can produce and sell products with a 40 percent
margin at a cost basis equal to 60 percent of the current transfer price. I have taken the cost of capital, labor, transportation
facilities and land into account when making these calculations. I estimate that our return on net assets (RONA) will be
approximately 55 percent.
This is an opportunity that we cannot ignore. We must act soon or others will seize it. I would like permission to pursue
detailed negotiations so that we can begin production within a year. Of course, I will submit a Capital Appropriations
Request for formal approval once you agree in principle with the project. I will also need technical support from both
Julie Anderson and Jerry Jackson to set up the manufacturing and technical information system, and assistance from our
legal department in working out the licensing agreements.
I look forward to seeing you at our next meeting, and to discussing my idea with you in greater detail at that time.
 Case 19 • Nova Incorporated: Two Sourcing Opportunities • 727

Nova Manufacturing, Inc.

‘‘Your Global Assembly Supplier’’

MEMORANDUM

To: John Fisher, CEO

From: Claudio Spiguel, President, Nova South America
Date: June 18, 2000
Subject: Maintaining Customer Service and Improving Nova Profitability
Attached is a copy of your recent memo on Customer Service and Cost as well as a copy of Larry Judge’s memo on
Lean Production. Sometimes it takes a combination of reminders like this to shake us loose from old habits and to drive
home the point that we can’t make marginal changes if we seek major improvements. Let me explain.
First, I am sure that my South America operations were a significant contributor to your memo. Recently we have
been maintaining generous amounts of inventory of finished goods in an attempt to provide superior service to our
customers. In addition, we have found that deliveries from Cincinnati and London have been more reliable. As a result,
we have succeeded in providing excellent service, which has led to a substantial growth in our business. While I knew at
the time I decided to increase my cycle stock and safety stock levels that costs would rise, I believed that it was the right
thing to do for our customers.
Then later, Larry Judge’s memo on RONA arrived. It reminded me that customer service was not the only goal for
Nova mangers. Making a ‘‘fair profit’’ for our shareholders on the assets they had provided us with was also important.
Since inventories are the greatest of the assets under my local control and their holding costs contribute heavily to our
operating expense, inventory reduction is my key lever for RONA improvement. I am torn between the goals of reducing
inventory and maintaining a high level of customer service. When I improve one the other gets worse.
When I shared this dilemma with a cousin who runs a manufacturing firm here in São Paulo, he asked for a sample
of each of the products that Nova sells in South America. After reverse engineering our ten products, he designed a
manufacturing process to build each and lined up a set of local suppliers. He has now offered me the following contract.
If I guarantee to purchase all Nova products sold in South America during the next five years from him, he will make
the capital investment required to manufacture them. He will sell them to us at our current Nova transfer price, quoted
in dollars to eliminate Nova’s exposure to Brazilian currency fluctuation, and he will guarantee the price for three years
(which Cincinnati will not do for me). Moreover, he will require no minimum order size and he will guarantee one day
delivery of any order quantity up to 2 percent of annual demand. Finally, he will pay all transportation costs and will
guarantee that product quality will meet or exceed Nova’s existing standards.
This is the answer to a prayer. He will own the pipeline stock, and I will need only two days of safety stock and
about a day of cycle stock. My fill rates will remain very high and my transportation costs will be negligible. From your
perspective, the risk of profit erosion from the wild currency fluctuations that we have experienced in recent years will be
eliminated. I estimate that my RONA bonus will exceed 40 percent and he feels that he will make an acceptable profit.
This is a win-win-win situation.
Do I have your approval to sign the contract and proceed with this new alliance?
728 • Case 19 • Nova Incorporated: Two Sourcing Opportunities

Nova Manufacturing, Inc.

‘‘Your Global Assembly Supplier’’

MEMORANDUM

To: All Nova Distribution Center Managers

From: John Fisher, CEO
Date: June 1, 2000
Subject: Customer Service and Cost
In the last two weeks I ran into a board member and then a college classmate, who each informed me that during the
past 6 months their companies had increased their purchases of our products. They were amazed at the increase in our
ability to serve them given that in the past we always were late and erratic in our shipping performance. Without having
details on products, regions, and dates, they assured me that what was a problem is now a real strategic advantage for us.
They wondered how we moved from last to first as a supplier in their industry.
While you all should be commended for following my instructions to improve customer service, recognize that our
costs have risen to the point where the increased demand and service reduces profitability. Let me be blunt. Unless we can
maintain the improved service levels at substantially lower operating costs, we will be out of business. You must reduce
your expenses—transportation, holding, and other overhead costs. Our ‘‘success’’ at increased customer service has
caused the additional problem of consistent overtime at factories that degrades factory performance through increased
scrap rates, increased setup times, and expedited transportation. At the management committee meeting this month, we
will review your plans and progress.

Nova Manufacturing, Inc.

‘‘Your Global Assembly Supplier’’

MEMORANDUM

To: All Nova Distribution Center Managers

From: Larry Judge, CFO
Date: June 8, 2000
Subject: Lean Production
To survive in our increasingly competitive business environment, it is imperative that we all strive continuously to
improve financial performance. Return on net assets, RONA, is a traditional and important measure of the effectiveness
with which productive assets are deployed by a company’s management. I have therefore decided to establish last year’s
RONA numbers as a benchmark for company performance. Hereafter, monthly RONA numbers at each location will
be used as a barometer to measure performance improvement as we move forward during the year.
I have calculated your 1999 RONA and will tie your compensation to your ability to improve it in 2000. The company
improvement goal of 10 percent must be met by all locations. Managers who exceed this goal will receive a salary bonus
percentage equal to twice their percentage improvement beyond 4 percent. I know you will each do the right thing.
 Case 20 • Ceras Desérticas and Mitsuba Trading Company • 729

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 20

CERAS DESÉRTICAS AND MITSUBA TRADING COMPANY

In October 1997, Mr. Juan Perez, CEO of Ceras Desérticas, EXHIBIT 1
S.A. de C.V., was reviewing the current situation of his com- HISTORICAL SALES FOR
pany. Consolidation was the word in the industry, so there CERAS DESÉRTICAS
were fewer competitors as time went by. Mr. Pérez was con- TONS PER QUARTER
sidering several alternatives for the future of Ceras Desérticas:
(a) use vertical forward integration, adding steps to his pro- 600
duction process, (b) sell the company to a Japanese customer, 500
500
who was aiming vertical backward integration, or (c) establish
a joint venture with the Japanese counterpart. 400
311
COMPANY BACKGROUND 300
200 158
Ceras Desérticas was established in 1995 as a producer of
candelilla wax. The manufacturing facility is located in Cuatro 100
Ciénegas, Coahuila, Mexico, while the company’s headquar- 0
ters is located in Saltillo, Coahuila. Additionally, there is a 1995 1996 1997
sales office in Mexico City. The company’s mission has been
to provide the highest quality product and to maintain strong EXHIBIT 2
customer relationships. Ceras Desérticas has international THE CANDELILLA PLANT GROWS IN THE
presence, exporting the candelilla wax to the United States,
DESERTS OF NORTHEASTERN MEXICO.
Japan, Europe, and South America.
Ceras Desérticas has been growing, reflected by its sales
THE STATES THAT ARE PRESENT IN THIS
volume increase throughout the period (see Exhibit 1). It has AREA ARE COAHUILA, DURANGO,
been able to get more customers around the world by assuring CHIHUAHUA, NUEVO LEÓN, AND
a stable supply, and by offering a competitive price and an ZACATECAS
excellent delivery service of its candelilla wax.
Environmental issues, such as reforestation and ensuring
the safety of its employees and neighbors, are concerns to
which Ceras Desérticas regularly devotes its attention. The
company is aware that in order to obtain candelilla wax, it must
have as a priority the conservation of the natural resource that
produces the wax. For that reason, the company has started
sowing candelilla shrubs as part of a reforestation plan.
Product
The candelilla is a natural wax found as a coating on can-
delilla shrubs. It is extracted from the surface of the stems
of candelilla plants, belonging to the family of the Euphor-
biaceas. The candelilla is mainly obtained from the Euphorbia
antysyphilitica or Euphorbia cerifera.
The candelilla plant grows in the deserts of northeastern
Mexico (see Exhibit 2). The plants that produce the candelilla Candelilla plants grow only in Mexico. This product has an
wax are wild; they grow in the hills and plains of the extensive advantage over other natural or synthetic waxes because there
semidesert regions in the states of Coahuila, Durango, Chi- are special applications in which candelilla wax is the only
huahua, Nuevo León, and Zacatecas. The plants thrive in this alternative for a particular product or process. The wide vari-
savage climate by producing a wax-type coating to protect it ety of uses makes it one of the most versatile waxes around. It
from the fierce sun and brutal winds. is not a commonly known product because it is not used alone.
The candelilla plant is mainly found at 900 to 1800 meters It is used as an extender in formulas containing carnauba,
above sea level. Historically, the largest wax content has been paraffin, and other waxes, but it also has hundreds of other
observed in those plants growing in the warmest and driest uses (see Exhibit 3). For example, it is used in candies such as
lands. chewing gums and breath savers, in cosmetics like lipsticks and
This case was prepared by Raúl E. Puente and Ryuichi Matsuo of the
blushes, and in pharmaceuticals. For industrial products, it is
Graduate School of Business at the University of Texas at Austin under the used in oils and lubricants, electrical conductors, explosives,
supervision of Masaaki Kotable of Temple University for class discussion paint removers, and so on. It is used in matches, wax paper,
rather than to illustrate either effective or ineffective management of a and car polish. See Exhibit 4 for an exhaustive list of uses.
situation described (January 1999).
730 • Case 20 • Ceras Desérticas and Mitsuba Trading Company

EXHIBIT 3
COMPARISON OF CANDELILLA WAX WITH CARNAUBA WAX

Properties Candelilla wax Carnauba wax

Growth area Mexico Brazil

Used in precision casting
waxes, perfect for lipsticks,
Main uses
dental waxes, waterproofing
agents and fabric finishes.
Cosmetics, particularly in
stick applications, food
coatings, pharmaceuticals,
electronics and polishes.

Low expansion and Hardest of natural waxes.

contraction coefficient,
durable, will not crack.
Physical Hard, glossy wax that
properties retains oils, emulsifiable
As seen in the table, the candelilla wax has a very important and has excellent gelling
quality. Having a low expansion and contraction coefficient, properties. Melting point
candelilla can be used in precision applications, and has the of 156 degrees Fahrenheit.
ability not to crack. On the other hand, carnauba, even
though it is the hardest of the natural waxes, is still brittle.
Brittle, non-tacky and
lustrous composition.
Retains oil, emulsifiable
and has excellent gelling
properties. Pale yellow;
highest melting point at
181 degrees Fahrenheit.

Production Process of the wax. In this manner, everything is recycled and nothing
goes to waste. After the wax has cooled down, it is broken into
The production of the candelilla wax consists of two different
smaller pieces to be fed into the second refinement process.
refinement processes. The first is done right in the field itself,
Once the cerote is brought to the facility, it is submitted to a
while the second refinement process is carried out in Ceras
second refinement process with the main purpose of removing
Desérticas’ facilities (see Exhibit 5).
all the impurities that the crude wax could still have, assuring
uniformity in the quality of the final product. Basically, the
process is very similar to the one performed in the fields. The
EXHIBIT 4
wax is fed into a heated caldron where it boils for several
USES OF CANDELILLA WAX hours; it is then left to cool down and broken into smaller
Candles, cosmetics Oils and lubricants
pieces in order to be packed as a final product.
Shoe polish, dentistry Electrical conductors The end candelilla wax that is sold to customers is packed
Crayons and pencils Explosives in 50 kilogram polypropylene sacks. These sacks help preserve
Insect repellents Linoleum and protect the wax from humidity and extreme temperature
Typewriter ribbons Waterproofing variations that can be present during transportation. The plant
Pharmaceuticals Paint removers
Emulsoidal wax Leather-tanning production capacity is 1,200 tons per year. Additionally, it is
Color varnishes important to mention there is an output 4 kilogram of wax per
Ointments Adhesive products 100 kilogram of plant.
Inks Cement
Paints Celluloid compounds
INDUSTRY
Candles Sealant waxes The candelilla wax industry has been very complex since its
Car polish Packaging formation in Mexico. It has been present in the Mexican
Carbon diaper Paper gumming
Matches
Republic since the late 1930s, when it was considered a very
Rubber compounds
Wax paper Projectile propulsor popular product, especially for the weapons and arms industry.
Floor & furniture polish Hardener for soft waxes During this period candelilla wax was used in bullets, inside
Textiles and plastics Molding compounds canyons, on ship building, etc., and its consumption severely
decreased after World War II ended. Later, the most known
applications of the wax today were starting to be developed,
During the first refinement process, the harvested can- and the wax regained its popularity for other industries other
delilla is transported to the extraction facility in the field. At than weapons and arms.
this point, the harvested candelilla is added to an earthen For the past 50 years, the Mexican government had tight
caldron, which is built into the ground. This caldron already is regulations on the production and sale of the candelilla wax.
filled with boiling water and a dilute amount of sulfuric acid In the past, it was traded freely, but when the government
to help extract the wax. The wax ‘‘boils’’ out of the candelilla realized the importance of this product it was taken over and
plant and floats to the top of the caldron. At this point the controlled. The government decided how much to produce,
farmers skim off the crude candelilla wax, called cerote, and at what price to sell, and to whom the campesinos or farmers
place the hot wax into a large drum to cool. After no more should sell. Later, as NAFTA was adopted (1993), the govern-
wax is left in the plants, they are shoveled out of the solution ment started to ease regulations; the candelilla wax industry
with pitchforks and allowed to dry in the hot sun; they will be was deregulated and it ended up in private hands. It was at this
used as fuel to heat the acid solution for the next extraction time when Ceras Desérticas was formed together with many
 Case 20 • Ceras Desérticas and Mitsuba Trading Company • 731

EXHIBIT 5
PRODUCTION PROCESS

Delivery of Manufacturing
Shrubs of "cerote" to facility facility
candelilla plant First refinement
process

Breaking of Bulk of
Packaging of candelilla wax candelilla wax
candelilla wax Second refinement
process

other companies that wanted to take advantage of this very Competition

unique and peculiar product.
Since the start of the deregulation process, the number of
Now, looking into the supply chain inside the candelilla
players in the candelilla wax industry has been reduced either
wax industry, it is important to mention the following. The
through takeovers, mergers, or bankruptcy. There are around
chain starts from the ejidatarios or landowners, who privately
fourteen different companies that would be regarded as com-
own the land on which they grow the candelilla plant. They are
petition for Ceras Desérticas. They all have close connections
in charge of handling the growing, harvesting, and delivering
to their own suppliers, or the ejidatarios. On a size basis, the
the plant to the primary refiners. During this process, they
largest supplier of candelilla wax is Ceras Desérticas followed
are also in charge of the reforestation of their own land—the
by Ceras Naturales de Mexico and Multiceras (see Exhibit 6);
process that is usually aided by the primary refiners as well.
the rest have a smaller market share. Both Ceras Desérticas
The next step in the process is the primary refiners, such as
and Ceras Naturales de Mexico specialize in candelilla wax
Ceras Desérticas, who buy from the ejidatarios. Interestingly,
and offer better customer service by focusing on one product
this step is always troublesome. The ejidatarios are not well-
instead of a wide assortment of products. The rest of the com-
educated people, and they usually work only to satisfy their
panies usually carry many other chemical products and other
basic needs—to get food, clothing, and shelter. Therefore,
natural and synthetic waxes, having a much wider assortment
they limit their work to get only what they consider enough.
of products to offer to the end customers.
For example, if the pay for each kilogram of harvest is 2 pesos,
they will work to collect 1 ton per day. If the pay goes up
EXHIBIT 6
to 4 pesos, they would only work to collect 1 /2 ton, which
MARKET SHARE
would give them the same pay. Therefore, it is very difficult
to have a steady and secure supply of product. Furthermore,
the government backs the ejidatarios for their social welfare. Rest
10%
Total output is expected to be around 1,000 metric tons this
year. Last year, the production output was 1,500 tons, but the
previous year it was around 750 tons. So as portrayed by these Multiceras Ceras
20% '
Deserticas
numbers, it is clear that there are many factors that are not
50%
controlled by the grower and are even less controlled by the Ceras
primary refiner, such as Ceras Desérticas. Naturales
'
de Mexico
Secondary refiners buy the candelilla wax in sacks from the 20%
previous refinement process. They remove impurities from
the wax and put in additives that will make the wax perform
according to the requirements of the final customer. They also
break the candelilla from the stone-like form that is delivered The barriers to enter into the candelilla market are very
from the primary refiners, and deliver it in flakes, powder, high. Considering the close and key relationship that the first
lump, or any form and shape required by the end customer. refiners need in order to start a business with the primary
Finally, the end customers buy from the secondary refiners suppliers, the ejidatarios, the entrance into the market cannot
to utilize the candelilla wax in a wide variety of ways, as be accomplished overnight. There is a time constraint as well
mentioned earlier. These end customers are present all over as a relationship constraint that is not built fast or obtained
the world. easily. On the other hand, there are some government issues
732 • Case 20 • Ceras Desérticas and Mitsuba Trading Company
that need to be considered, because as was mentioned before,
there is government backup for the ejidatarios. Therefore,
people approaching this kind of business need to be aware of
the way the ejidatarios work.
In addition to this, considering the potential substitute
alternatives that can be developed for the uses of the candelilla
wax, there is always a constant threat for the development of
an exact substitute that will make candelilla wax vulnerable to
the synthetic wax market. It is clear that a synthetic substitute
will always be more cost competitive than a natural product,
especially if the weather and other factors that are out of the
farmer’s control are taken into consideration. Additionally,
the research in this field is well advanced especially in the
United States.
Ceras Desérticas International Trading
Ceras Desérticas has all its customers outside the Mexican
Republic. As was mentioned before, all the main customers
are based in the United States, Japan, and Europe, having
marginal exports to other places around the world. How-
ever, this doesn’t mean that there are no Mexican consumers
of candelilla wax. The main industries that consume can-
delilla wax in Mexico are the candy industry (specifically
the gum manufacturers, the paint industry, and the polish
industry).
The U.S. market is the main customer for this company,
taking around 70 percent of the total sales volume. Japan, on
the other hand, accounts for 15 percent, while Europe has 10
percent (see Exhibit 7). In the United States, the main cus-
tomer is a company called Strahl & Pitsch. On the Japanese
market, Mitsuba Trading Company and Chiyoda Corporation
are the main customers. Hermann Ter Hel Company, located
in Germany, is also a customer.
Looking at trading, Ceras Desérticas exports candelilla wax
to Japan through the port of Manzanillo on the Pacific Ocean.
EXHIBIT 7
CERAS DESÉRTICAS EXPORTS
U.S.A.
Exports of candelilla Europe
wax by destination: Japan
Rest of World
Exports going to Europe and South America go through the
port of Veracruz, while to the United States the exports are
sent though Laredo, Texas. The exports that go overseas are
sent by ship, while the product going to the United States is
sent by truck.
Price is another important issue. It is usually handled in
US$/ton, varying according to the destination of the product.
The product is usually sold FOB Mexican port (Manzanillo or
Veracruz) or FOB border, in the case of ground transporta-
tion. The current price for the candelilla wax is the following:
for the U.S. market, the price is US $2,650/ton, while for the
rest of the world, the price is US $2,700/ton. With these num-
bers, the 1997 figures for the export sales of candelilla wax
account for US $1,026,000. This number is the result of con-
sidering the percentage sales by destination and the current
prices.
Several Mexican companies have carried out joint ventures
with American companies in order to become sole suppliers
to the U.S. market, and the Mexican competition for Ceras
Desérticas is assuring a steady sales volume. Ceras Desérticas
has been approached on several occasions by different com-
panies—not from the United States, but from Japan. With
Strahl & Pitsch there is a strategic alliance for the supply of
candelilla wax. This company has, to date, the most advanced
research and development site in the world.
The possibility of selling the company, making a joint
venture, or vertical forward integration has gone through
the minds of Ceras Desérticas executives. They are will-
ing to look into the different alternatives to pick what best
suits the company and its future in the candelilla business
market.
Taking a step back into production, it was mentioned
that Ceras Desérticas had a manufacturing capacity of 1,200
tons, while the actual output for 1997 will be only 500 tons.
There is a real lack of capacity utilization, and improving the
70%
10%
15%
5%
 Case 20 •
EXHIBIT 8
MITSUBA’S LOCATIONS IN JAPAN
Nagoya branch office
Suzuka branch office
Osaka branch office
Mizushima branch office
Hiroshima branch office
Fukuoka branch office
export market, especially to those areas that are low (Japan,
Europe and the rest of the world), is a primary concern for its
executives. This is the main reason why Ceras Desérticas exec-
utives are looking carefully at the option of partnering with a
Japanese company. Mitsuba Trading Company is a very large
trading company. The advantage of a Japanese joint venture,
rather than with an U.S. company, is that Americans are not
interested in bringing research to Mexico, just assuring the
supply of the wax. On the other hand, the Japanese are willing
to invest in research and development, as well as educating
the labor force of Ceras Desérticas.
MITSUBA CORPORATION
Since Mitsuba was founded in 1946, it has provided gener-
ator lamps for bicycles and electrical components for motor
vehicles, all the while maintaining and developing cooperative
relationship with the local community of Kiryu City, lying 120
km north of Tokyo (see Exhibit 8). In 1997, its capital became
9.86 billion Japanese yen (US$ 79 million) and its annual sales
were 81.12 billion Japanese yen (US$ 649 million) in 1996 (see
Exhibit 9).
It is expanding markets of motorization and globalization
of automotive electronics. This has enabled its products to
reach every part of the world. Recently, it has ambitiously
undertaken new businesses and has expanded its enterprise
to automobile, chemicals, industrial equipment, and medi-
cal equipment. Mitsuba’s affiliated companies extend inside
and outside of Japan covering production, sales, physical
distribution, and system integration.
Since 1971, Mitsuba has promoted the establishment of
operations in every part of the world through technical
cooperation with manufacturers. Additionally, it has begun
production in North America, including two plants in the
United States and one plant in Mexico. It has plants in South-
east Asia and China. According to a recent announcement,
Mitsuba will positively develop and expand all functions,
including marketing, research and development, production,
and local sourcing, to form a ‘‘Tri-Axial’’ organization (see
Ceras Desérticas and Mitsuba Trading Company • 733
Sapporo branch office
Head branch office
Utsunomiya branch office
Tokyo branch office
Atsugi branch office
Hamamatsu branch office
Exhibit 10). Mitsuba plans to grow as a global firm of the new
age by making all functions international.
EXHIBIT 9
MITSUBA’S COMPANY OUTLINE
Established March 8, 1946
Capital 9,860,000,000 Japanese yen
Annual Sales 81,116,000,000 Japanese yen (actual
1996 sales)
Employees 2,774 (2,064 men and 710 women)
Average Age 36.0 years old (36.7 for men and 33.7 for
women)
Operations Production and Sales of
Automotive Electronic Components
Mitsuba Trading Company
Mitsuba Trading Co., Ltd. is located in Nitta Country, close
to Kiryu City, Gunma Prefecture. In the distribution indus-
try, Japanese general trading companies have been providing
comprehensive distribution functions to their suppliers and
buyers by utilizing affiliated companies and related compa-
nies. These functions include founding warehouses, processing
goods, distributing processed goods to buyers, and operating
information systems to support distribution. Like the general
trading company, Mitsuba Trading Company has been playing
an important role within Mitsuba group.
Mitsuba Trading Company started business with Ceras
Desérticas in 1996. It imports the candelilla wax from Mexico
and hand it over to the affiliated companies to process it.
The affiliated companies produce more nearly finished wax
then the secondary refiner does. In addition, these companies
transform the pebble-like candellila wax into flakes, powder,
or any form required by the final customers. Mitsuba Trading
Company distributes this more highly processed candellila
wax to the end customers.
734 • Case 20 • Ceras Desérticas and Mitsuba Trading Company
EXHIBIT 10
MITSUBA’S TRI-AXIAL PLAN
America
Localized production 2
Sales 1
Technical cooperation 1
Candelilla Wax Market in Japan
Mitsuba actually dominates the domestic trading of candelilla
wax. It had been importing the candelilla wax from Mexico
since the 1950s as an exclusive agent in the Japanese market
and Southeast Asian market up until the deregulation by the
Mexican government.
The candelilla wax is used for various purposes in Japan.
For example, it is used for shoe polish, auto wax, insulating
tape, lipstick, chewing gum, candy, crayon, waterproofed
cloth, and dyestuffs. Recently, candelilla wax use grew in
to three industry areas: cosmetics, foods, and information
recording devices (i.e., ink for printer and copy machines).
In the foods industry and the cosmetics industry, demand
for the candelilla wax is growing remarkably. Both industries
have recognized that candelilla wax is a necessary ingredient
for their products. A food company, for example, is thinking
of expanding tablet gum in the Japanese market, which is
dominated by Warner Lambert, a U.S. food company, and
Lotte, a Korean owned company.
The food industry has the lowest requirement for quality
candelilla wax. On the other hand, the cosmetics and the infor-
mation recording device industry have higher requirements
for quality. Consequently, price of secondary refinement can-
delilla wax in Japan is according to the user’s requirement. For
example, the price of first refinement candelilla wax is US$2.7
per kilogram in Japan. The price of the second refinement
candelilla wax for foods industry is US$6 per kilogram. For
the cosmetics industry, the price rises to US$100 per kilogram
because the finest refinement is required.
Several years ago, one of the big primary refiners in Mexico
processed the second refinement in Mexico utilizing Ger-
man equipment with German engineers’ assistance. Mitsuba
Europe
Technical cooperation 4
Asia
Localized production 5
Sales 1
Technical cooperation 9
imported the second refinement candelilla wax at US$3.4 per
kilogram from the company. However, the quality of the sec-
ond refinement wax could not meet any Japanese end-users’
requirements. Deodorization and the alien substances are the
main problems.
Distribution channels of candelilla wax in Japan are com-
plex. Mitsuba, for example, cannot sell the wax directly to one
of the biggest food companies. It has a huge demand for can-
delilla wax because the food company is supplied all of ingre-
dients from limited numbers of exclusive trading companies,
such as Marubeni and Mitsubishi. Similar situations exist for
other companies that have historical relationships with big
Japanese trading companies.
Japanese Regulation
Ceras Desérticas has faced regulation by the Japanese gov-
ernment regarding the export of candelilla wax as imported
by the Japanese second refiners. The Japanese Ministry of
Welfare is responsible for products going into Japan that may
be hazardous or dangerous.
This government agency requires that candelilla wax com-
ing from primary refiners, such as Ceras Desérticas, must go
through a second refinement process in order to meet the
requirements set by the Ministry of Welfare.
This has been a hidden trade barrier that has prohibited
Mexican companies from selling directly to the end consumers
in Japan, having to go through the trading companies in order
to reach its customers. It is important to mention that refined
candelilla, such as that produced by secondary refiners, is not
subject to this requirement from the Ministry of Welfare.
Mitsuba Trading Company comes into the trade chain by
taking the first refined candelilla wax, treating it in order to

comply with regulations, and selling it to the end users while
making a profit. In addition, there is a tariff for the import of
candelilla wax into Japan of 3.8 percent; this is for either first
or second refined candelilla wax.
FUTURE OF THE CANDELILLA WAX INDUSTRY
According to executives of Ceras Desérticas, the future of
this market is promising. They expect growth in the future,
although they they have not made public the actual estimated
growth for the market. They are worried about the best path
to take advantage of this growing and competitive market.
The industry is consolidating and if Ceras Desérticas does
nothing, it will either die or be taken over. As mentioned
before, there are several joint ventures in which U.S. com-
panies are investing in Mexico to guarantee a steady supply
of candelilla wax. Both Ceras Nacionales de Mexico and
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 21
THE HEADACHES OF GLAXOWELLCOME
Migraine medicine is a key growth area for Glaxo Wellcome
Inc. (Glaxo); a Britain-based pharmaceutical company with
global operations.1 Glaxo’s primary business is to market
prescription products to physicians and healthcare providers.
Glaxo was the first pharmaceutical company to manufacture
and market a revolutionary new class of prescription migraine
medications called ‘‘triptans’’. Triptans, which Glaxo launched
in 1993, are a class of medications that work specifically on
the 5HT-1 receptor sites, which are believed by doctors to be
the primary cause of migraine headaches.
In mid May of 1997, Sir Benjamin Palmer, the general man-
ager of Glaxo’s CNS/GI Metabolic division, sat at the head
of the conference table in room G-1 of the Glaxo Wellcome
global headquarters in Stockley Park West, England. A group
of 6 marketers (3 from the ‘‘Professional’’ team and 3 from the
‘‘Commercial’’ team) were staged in front of Palmer and two
vice presidents of sales (East and West). The three officers
listened attentively to the final marketing presentation that
more than 60 marketing team members had worked on for the
past 19 months. The issue: How to launch Naramig, Glaxo’s
new (second generation) prescription migraine medicine, in
the U.K. In the back of Palmer’s mind were the following
considerations:
• How would U.K. hospitals and doctors react to Glaxo’s
promotion of Naramig?
• What was the best product positioning of Naramig with
respect to Imigran?
This case was prepared by Jared Fontaine, Aaron C. Lennon, and Robert
Moscato of the Fox School of Business and Management at Temple Univer-
sity under the supervision of Professor Masaaki Kotabe for class discussion
rather than to illustrate either effective or ineffective management of a
situation described (2001).
1 Today the company is known as GlaxoSmithKline, which was formed
in January 2001 as the result of a merger between GlaxoWellcome and
SmithKline Beecham.
Case 21 • The Headaches of GlaxoWellcome • 735
Multiceras have established joint ventures with American
companies. They are pursuing research and development to
try to create a synthetic wax that can replicate the char-
acteristics of candelilla wax and meet the requirements of
end-users.
DISCUSSION QUESTIONS
1. Of the three options options presented at the beginning of
the case, what should Ceras Desérticas do?
2. Why would Mitsuba Trading Co. be interested in a joint
venture with Ceras Desérticas?
3. What would be the advantages and disadvantages for Ceras
Desérticas of a joint venture?
4. What strategy must Ceras Desérticas follow in approaching
joint venture?
– Although Naramig was considered by Glaxo to be a better
triptan than Imigran, in reality, there were some attributes
of Naramig that were inferior to those of Imigran.
– It was not as if Imigran had not been successful: Glaxo
had captured 91 percent of the prescription medication
market share (in £s) for migraines in the U.K.
– Glaxo expected the approval and launch of its competitor,
Zeneca’s first triptan medication (Zomig) prior to that of
Naramig, and likewise, expected Zeneca to market Zomig
as a 2nd generation triptan.
8 12 Months Later
Early in February of 1998, a similar scene to that of 8 12 months
ago, in room G-1 of the U.K. headquarters, was taking place in
a conference room located at the U.S. home office in Research
Triangle Park, North Carolina. Mark Glackin, U.S. General
Manager of Glaxo’s CNS/GI Metabolic Division, considered
several marketing options presented by the team for the U.S.
launch of Amerge, Glaxo’s second-generation triptan that had
been marketed in the U.K. as Naramig.2 Although Glackin
had several considerations to keep in mind, various factors
and events gave Glackin a much different perspective than
that of Palmer 8 21 months earlier:
• Glaxo was apprised of the marketing strategy chosen by the
U.K. for Naramig and its short-term results.
• Zeneca’s Zomig had in fact been approved and launched
in the U.K. prior to that of Naramig. The effects of Zomig
on the success of Naramig and Imigran were therefore
available for analysis by Glackin.
• Just as in the U.K., Glaxo U.S. expected the approval
and launch of Zomig in the U.S. prior to that of
Amerge.
2 Like Amerge/Naramig, Glaxo’s research indicated that the name Imitrex
would fare better than Imigran in the U.S. market.
736 • Case 21 • The Headaches of GlaxoWellcome

EXHIBIT 1
The Businiess
GW Portfolio: 1998

£1,027m (+9%) % of Sales

£1,971m (+24%)
Respiratory 28
£432m (+5%)
Viral Infections 17
CNS 15
£688m (−44%)
Migraine 9
Bacterial Infections 10
£749m (+1%)
£1,209m (−4%) Gastro-intestinal 10
Oncology 6
£1,089m (+31%)
(Migraine £645m) Others 14

Total sales £7,165m

increase of 2%

• Glaxo U.S. had launched the marketing promotion of Product Lines:

Imitrex (the U.S. brand name of U.K.’s Imigran)3 Nasal
Spray 5 months earlier.
• Unlike the U.K., which has stricter government regulations
on pharmaceutical marketing, Glaxo U.S. could use direct-
to-the-consumer (DTC) advertising to promote Amerge.
COMPANY BACKGROUND
GlaxoWellcome Inc. was formed in 1995 when U.K.-based
Glaxo Pharmaceuticals, a relatively young company, acquired
U.K. pharmaceutical company Burroughs Wellcome in a cor-
porate takeover. The acquisition made Glaxo Wellcome Inc.
one of the top three pharmaceutical firms in the world with
approximately 4 percent of the worldwide prescription phar-
maceutical market.
International Organization
GlaxoWellcome Inc. is based in the U.K. with its World-
wide Headquarters located in Stockley Park West. As of
1997, Glaxo Wellcome Inc. had 22 local operating companies
(LOCs) in 9 countries of which Glaxo U.S. was one. Although
based in the U.K., the U.S. market made up approximately
40 percent of worldwide sales, while the U.K. only accounted
for 7 percent. Due to the rigid guidelines of the Food and
Drug Administration (FDA), Glaxo’s products are generally
introduced first in one of the other 8 LOCs before gaining
approval in the U.S. The majority of R&D and production for
Glaxo takes place in the U.S., U.K., France, and Italy, each
having both an R&D unit and manufacturing plants.
Organizational Structure/Product Lines
The organizational structure of Glaxo Wellcome in both the
U.K. and the U.S. is based around its 3 divisions and the
product lines within each of those divisions:
• Central Nervous System/Gastrointestinal Metabolic Divi-
sion (CNS/GI)
3 Market research showed that U.S. consumers would be more responsive
to the brand name ‘‘Amerge’’ than that of ‘‘Naramig.’’
Migraine
Depression
Gastrointestinal
• Allergy/Immunology/Respiratory Division
Product Lines:
Allergy/Immunology
Asthma
COPD
• HIV/Oncology Division
Product Lines:
HIV
Cancer
Glaxo sells prescription medications that fall into one of
these three product lines. As of 1998, the migraine product line
made up just over 9 percent of total Glaxo sales worldwide.
The CNS/GI Metabolic division, of which migraine makes up
60 percent, grew 31 percent from 1997 to 1998 (see Exhibit 1).
THE PHARMACEUTICAL INDUSTRY
Pharmaceuticals are generally classified into two categories:
over-the-counter (OTC) and prescription medications. As
of 1998, there were no OTC drugs specifically formulated
for migraine. After a pharmaceutical medication has been
developed, there are two stages: approval and marketing.
Approval
In order for a pharmaceutical company to market and sell
any medication that they have developed, the product must
first be approved by the respective regulatory body of each
country (FDA in the U.S., MCA in the U.K.). On average it
takes 12 years for an experimental drug to travel from the lab
to the medicine chest. Only five in 5,000 compounds that enter
preclinical testing make it to human testing. One of these
five tested in people is approved. Although each country has

its own particular set of guidelines and specific procedures
for approval, new medicines are generally developed and
approved as follows:
1. Preclinical Testing—This is the exploratory process where
a pharmaceutical company identifies compounds through
in vitro (test tube) testing. The deliverable at the end of
this process are compounds that can enter Phase One of
Clinical Testing.
2. Clinical Trials, Phases—There are three mandatory phases
of clinical trials. These clinical trials study the medicine’s
safety profile, how it is absorbed and distributed, the dura-
tion of its action, its efficacy, and side effects.
3. Application—Following the completion of all three phases
of clinical trials, the company analyzes all of the data
and applies for approval in the respective country if the
data successfully demonstrate safety and effectiveness. The
application contains all of the scientific information that the
company has gathered. At this point, the regulatory body
may request further information.
4. Approval/Refusal—Once the regulatory body completes
the professional assessment of all relevant information,
it either approves the application and the new medicine
becomes available for physicians to prescribe, or, if unsat-
isfied, refuses to grant approval.
There is one important distinction between the U.S. and
the U.K. in the approval stage of pharmaceuticals. In the U.S.,
every medication must be approved by the FDA before it can
be marketed and sold. However, because of the existence of
the European Union (EU), it is possible that a medication
may be approved in member nations without being profes-
sionally assessed and analyzed by each country’s respective
regulatory body. This means that if one member nation’s
(e.g. Sweden’s) regulatory body approves a medication, the
applying pharmaceutical company can either ask the other
EU member nations to ‘‘recognize’’ Sweden’s approval or
apply to each member nation separately. If one member
nation approves a medication, then all of the countries in the
‘‘Mutual Recognition’’ procedure have the same prescribing
information. However, if a medication receives independent
approvals, then the prescribing information will be unique in
each country. The difference can have an effect if applying
in each country separately produces slightly different results
in the trial phases (e.g., perhaps the trials show that a med-
ication is more effective for its desired indication during
trials in the U.K. as compared to similar trials performed in
Sweden).
Marketing
In general, products are marketed and advertised solely
toward the final consumer. This makes sense since it is the final
consumer that ordinarily has the final say as to whether he/she
will actually purchase the product. However, pharmaceuticals
are marketed to physicians and hospitals that in turn decide if
they will prescribe the medication to their patients.
U.S. vs. U.K
Although it is illegal for pharmaceutical companies to adver-
tise their products directly to patient/consumers in the U.K.,
Case 21 • The Headaches of GlaxoWellcome • 737
in the U.S. (as of 1997) direct-to-consumer (DTC) advertis-
ing is permitted. Research has shown that DTC advertising
in the U.S. has a large impact on sales. The research shows
that patient’s requests for specific medications marketed by
specific pharmaceutical companies affect the companies’ sales
to physicians and hospitals.
The other major difference in the pharmaceutical industry
between the U.S. and the U.K. is the extent of governmental
coverage. In the U.K., the health care system is socialized.
Doctors are paid by the government with an additional pay-
ment per patient. Everyone is entitled to free medical care
under the plan, which is funded by the National Treasury and
Health Insurance Tax.
The U.S., on the other hand, has not employed socialized
medicine, although Medicare and Medicaid cover a significant
part of the population. Instead, the U.S. health care system
follows an insurance-based coverage scheme whereby individ-
uals buy insurance from a company, which in turn pays for
their medical costs.
HEADACHES AND MIGRAINES
Doctors classify headaches into three main types:
• cluster headaches
• tension-type headaches
• migraines
Cluster headaches are the most painful type but also quite
rare and hence have not offered pharmaceutical compa-
nies a sufficient market potential to profitably develop and
market a medication specifically focused on curing these
headaches. Tension-type headaches, while the most prevalent,
are generally capable of being combated with over-the-counter
medications such as aspirin and ibuprofen and hence, likewise
do not offer Glaxo a profitable market for which to develop
a prescription product. Migraines, on the other hand, are
suffered by an estimated 26.3 million people in the U.S.,
5 million people in the U.K., and at the time of Glaxo’s
launch of Imigran/Imitrex, were not effectively treatable with
over-the-counter medications.
Migraines are complicated combinations of intense pain
(usually on one side of the head) and neurological symptoms
like visual problems, nausea, vomiting, and sensitivity to light
and sound, which often reduce the sufferer’s productivity and
concentration and in some cases render the sufferer bedrid-
den. In the U.K. about 18 million working days are lost to
migraine sufferers a year. In the U.S. approximately 10 mil-
lion migraine sufferers were bedridden for more than 3 million
days per month and experienced 74.2 million restricted activ-
ity days per year (as of 1989). Such statistics translate to lost
workplace productivity ranging from $5.6 billion to $17 billion
annually in the U.S. and sick pay and replacement person-
nel costs of £750 million in the U.K. annually. Hence, in the
early 1990s, Glaxo took advantage of the market potential for
migraine-specific prescription drugs.4
4 At the time of Glaxo Wellcome Inc.’s entrance into the market for pre-
scription migraine medicines, although doctors were prescribing drugs for
migraines, these drugs were not migraine-specific but rather were drugs
that were developed for general pain relief.
738 • Case 21 • The Headaches of GlaxoWellcome

IMIGRAN/IMITREX uncomfortable injecting themselves). Sales of Imitrex/Imigran

In 1993, Glaxo Pharmaceuticals introduced Imitrex/Imigran5
in the U.K. and the U.S., the first medication (triptan)
specifically formulated for the acute treatment of migraine.6
Imitrex/Imigran when initially launched in March of 1993 was
produced in injection form. In 1995 and 1997, Glaxo followed
up the marketing of Imitrex/Imigran by introducing line exten-
sions in the forms of tablets and nasal spray, respectively (see
Exhibit 2).
EXHIBIT 2
Line Extension U.K. U.S.
Injection 3/1993 3/1993
Tablet 5/1995 7/1995
Nasal Spray 5/1997 8/1997
These line extensions were spurred by the fact that only
a small percentage of the total 26.3 million migraine suffer-
ers had ever tried Imitrex/Imigran in injection form. Hence,
Glaxo, even 2 years after the introduction of Imitrex/Imigran
injections, viewed the potential market as wide open.
The injection formulation of the product provides the
fastest relief—as early as 10 minutes; the nasal spray—as
early as 15 minutes; and the tablet—as early as 30 minutes.
Hence, Glaxo has been successful marketing the injection
form of Imitrex/Imigran using a strategy of ‘‘quick-relief’’ (an
aspect that is very important to severe migraine sufferers) and
successful marketing the tablet and nasal spray forms of the
drug using a strategy of ‘‘easy and painless administration’’
(an aspect that is important to migraine sufferers who are
5 The launch of Imigran/Imitrex came prior to the Glaxo Pharmaceuticals’
acquisition of Burroughs Wellcome, Inc.
6 Glaxo used the brand name Imitrex in the U.S. and the brand name
Imigran in the U.K. for the same product. Market research showed that
the name Imitrex would fare better with U.S. physicians and hospitals.
worldwide grew from less than $350 million in the year of its
introduction to more than $1 billion in 1997.
Imigran/Imitrex SWOT
Glaxo considered the strengths, weaknesses, opportunities,
and threats of Imigran/Imitrex to be the following:
Strengths—Imigran/Imitrex was the first medication mar-
keted toward specific migraine relief. Hence, Imigran/Imitrex
had a strong brand image as the market leader, and in fact
played a significant role in the development of the migraine
market. Imigran/Imitrex was also a potent medication with a
proven efficacy; it was in fact very successful in relieving the
pain of migraine headaches. Although there were some side
effects associated with the medication, Imigran/Imitrex has a
proven safety profile. The fact that Imigran/Imitrex is offered
in 3 different line extensions offers Glaxo a ‘‘portfolio’’ of
relief to offer to various patients.
Weaknesses—The fact that Imigran/Imitrex is a potent
medication has its downside as well. The medication proves to
be too powerful for some patients, which therefore limits its
use. Moreover, Imigran/Imitrex is expensive relative to OTC
products that were used to fight headaches. This weakness of
being expensive is exacerbated by the fact that the medication
has a high rate of recurrence (a patient may need to take
the drug more than once during a migraine). Although Imi-
gran/Imitrex is proven to be safe, because of the side effects
(e.g., tightening of the chest), there is a perception by some
that the medication is not safe.
Opportunities—Glaxo felt that having 3 product line
extensions opened up the opportunity to perhaps exploit
Imigran/Imitrex as a medication that is right for every kind
of migraine sufferer. The biggest opportunity for Glaxo and
Imigran/Imitrex is the fact that the migraine market was
completely underdeveloped.

EXHIBIT 3

GlaxoWellcome Worldwide
Migraine Franchise
$m
1,200

1,000

800

600

400

200

0
1993 1994 1995 1996 1997 1998

Injection Tabs Nasal Spray


Threats—The two main threats to Imigran/Imitrex are
that of competition and cannibalization. Glaxo was aware that
Zeneca was close to marketing a competitor triptan called
Zomig. Since Imigran/Imitrex had been on the market for
over four years, Glaxo felt that Zomig would be marketed as a
‘‘second-generation’’ triptan (an improved version of Glaxo’s
first-generation Imigran/Imitrex). Imigran/Imitrex had also
experienced some cannibalization effects between its 3 line
extensions (see Exhibit 3).
The Underdeveloped Migraine Market
As of 1997, the fact of the matter, was that approximately 90
percent of migraine sufferers were not being medicated with
a triptan (see Exhibit 4). This meant that many people were
still taking ineffective OTC drugs to combat their migraine
pain. Accordingly, Glaxo considered the market for ‘‘triptan’’
drugs to have great potential.
EXHIBIT 4
Migraine market = underdeveloped
48 million migraine patients
586 million migraine attacks/year
Triptan Rx = 10%
60
526
Million Attacks
Since its introduction in 1993, Imitrex/Imigran had clearly
played a role in defining patient expectations. However,
combining its awareness that Zeneca was in the process of
developing Zomig and the fact that Glaxo, as a company, was
always looking to bring new medications and improvements
to the forefront, Glaxo had worked on developing a second-
generation triptan of its own. Company research revealed that
for a new triptan product to be successful, patients and doctors
would require it to be as effective as Imitrex/Imigran but with
a longer duration of pain relief and a lower side effect profile.
NARAMIG/AMERGE
Naramig/Amerge, Glaxo’s second-generation triptan, was
actually being developed prior to the launch of Imigran/
Imitrex.7 Amerge/Naramig, only available in tablet form,
tested to have both a longer duration and a lower side effect
profile than Imigran/Imitrex. Although Naramig/Amerge
was considered by Glaxo to be a better triptan than Imi-
gran/Imitrex, in reality, there were attributes of Naramig/
Imigran that were inferior to those of Imigran/Imitrex.
7 Glaxo, as with Imigran/Imitrex, used the brand name Naramig in the
U.K. and the brand name Amerge in the U.S. for this new ‘‘triptan’’ drug.
This decision was once again a product of market research.
Case 21 • The Headaches of GlaxoWellcome • 739
Exhibit 5 shows how Naramig/Amerge specifically com-
pared to Imigran/Imitrex as a migraine medication.
EXHIBIT 5
Imigran vs. Naramig
MEASURE ORDER (best first)
Speed of onset Imigran > Naramig
Peak efficacy Imigran > Naramig
Consistency of response Imigran > Naramig
Tolerability Naramig > Imigran
Incidence of chest pain Naramig < Imigran
Incidence of recurrence Naramig < Imigran
Naramig/Amerge SWOT
Glaxo considered the strengths, weaknesses, opportunities,
and threats of Naramig/Amerge to be the following:
Strengths—Although not as powerful as Imigran/Imitrex,
Naramig/Amerge was effective in relieving migraine pain.
Its biggest strength, relative to Imigran/Imitrex was its mild-
ness; the side effects caused by Naramig/Amerge were sub-
stantially less compared to Imigran/Imitrex, which gave it
‘‘user friendly’’ image. Its long duration of pain relief gave
Naramig/Amerge a low rate of recurrence; 67 percent of
patients require only one dose of Naramig/Amerge over a
24-hour period. Naramig/Amerge was able to be marketed
as a true second-generation triptan (an improvement on the
first) since Glaxo was the company that had introduced the
first triptan medication.
Weaknesses—The major weaknesses of Naramig/Amerge
were twofold. First, it had a slow onset of action. This of
course would turn off patients looking for fast relief. Second,
Naramig/Amerge had only been developed in tablet form and
therefore lacked marketability in terms of line extensions.
Opportunities—The market opportunity for Naramig/
Amerge was quite obvious. At the time of Naramig/Amerge’s
approval, only 10 percent of all migraine attacks were being
treated with triptan drugs. This meant that 90 percent of
migraine sufferers were either not being treated at all, or
treated with relatively ineffective medications.
Threats—Like Glaxo’s first-generation triptan, Naramig/
Amerge’s biggest threat came from Zeneca’s Zomig. Although
it was unclear how successful Zomig would be in stealing
Glaxo’s market share and expanding the market through sales
to the untapped 90 percent, what was clear was that Zomig
was likely to be approved in both the U.K. and the U.S. prior
to Glaxo obtaining approval for Naramig/Amerge.
COMPETITION
When Glaxo Pharmaceuticals acquired Burroughs Wellcome
in 1995, they had already launched Imigran/Imitrex (1993).
740 • Case 21 • The Headaches of GlaxoWellcome
However, Burroughs Wellcome was also developing a triptan
of its own. When the takeover took place, the Federal Trade
Commission (FTC) forced Glaxo Wellcome to divest one of
its triptan formulations because of antitrust implications (i.e.,
monopolization). Having already successfully marketed Imi-
gran/Imitrex, Glaxo Wellcome of course chose to divest the
triptan that Burroughs Wellcome had developed. (Burroughs
only completed about 55 percent of the clinical trials.)
Zeneca purchased the rights to this incomplete triptan and
finished the further development and application process of
what came to be Zomig. Glaxo had the following assumptions
about Zomig:
• Like Naramig/Amerge, Zomig had a lower recurrence rate
than Imigran/Imitrex.
• Zeneca would be successful in marketing Zomig as a second-
generation triptan even though it was the company’s first
triptan. This was simply an issue of timing.
• Zomig’s efficacy was comparable to Imigran/Imitrex.
• Zomig would be launched in both the U.K. and the U.S.
prior to Naramig/Amerge gaining approval in both markets.
PRODUCT POSITIONING: U.K
Sir Benjamin Palmer sat in his office weighing all the infor-
mation he had just learned in the marketing meeting. There
was only question to be considered; the considerations were
complex; the answer to that question was crucial: the success of
a major product line of Glaxo Wellcome hung in the balance.
How should Glaxo Wellcome U.K., position its new triptan
Naramig?
Palmer wondered how U.K. hospitals and doctors would
react to Glaxo’s promotion of Naramig when Imigran had been
the ‘‘gold standard’’ for the past 4 years and had captured 91
percent of the prescription migraine medication market share.
Palmer’s bigger concern was how to position Naramig with
respect to Imigran in order to capture the 90 percent of the
market that was untapped (see Exhibit 4). Although Naramig
was considered to be a better triptan than Imigran, perhaps
there were new patients who would be partial to the charac-
teristics of Imigran. Just as important was what positioning
strategy would be the most effective in fighting off the attack
of Zeneca’s Zomig that Palmer expected to be launched in the
U.K. prior to that of Naramig.
Palmer had been presented by the marketing team with
five positioning strategies for Naramig:
1. Based Segment: Whereby Glaxo would target its market-
ing efforts toward different patient types. (e.g., adolescents;
elderly; chronic migraine; Imigran/Imitrex nonresponders;
and patients who do not tolerate Imigran). Using such a
strategy would allow Glaxo to promote Naramig where
Imigran was weak to increase market share. At the same
time, though, it was not clear as to how the market should
be segmented, or how able physicians would be to identify
such segments. If in fact physicians had trouble identifying
the different patient types, the effect may be to confuse the
prescribing process.
2. Distribution Based Segment: Whereby Glaxo would seg-
ment the market based on distribution channels. (e.g.,
hospitals only; clinics only; private channels; less wealthy
areas). Although Glaxo considered this option to be a
powerful means of maximizing market share, Palmer was
unsure of the logistics of such an approach and worried
about the ethical considerations of focusing the promotion
of their product in areas based on factors such as socioeco-
nomic status. Also, Palmer considered the fact that such a
strategy may overlook patient needs.
3. An Alternative: Whereby Glaxo would market Naramig as
an alternative to Imigran/Imitrex, (e.g., superior; different;
similar). The pros of the ‘‘Alternative’’ strategy were that
it could detract from competitor noise, and could in fact
devalue the image of the second-generation triptan. This
latter aspect may be an effective way to combat Zomig.
The biggest drawback of this strategy was the idea that if
there were no clear message (in terms of the medication
that was best for migraines) it could lead to confusion and
hence hurt Glaxo’s image.
4. Replacement: Whereby Glaxo would discontinue the mar-
keting of Imigran and focus solely on Naramig. This option
fit well with the overall concept that Naramig was an over-
all superior drug to Imigran. It would also allow Naramig
to gain all the benefits of a new compound: ‘‘second-
generation,’’ safety, and low recurrence. However, Palmer
worried about the confusion that would accompany such an
approach and if a ‘‘Replacement’’ strategy would devalue
Glaxo Wellcome in the eyes of physicians and hospitals.
5. Don’t Launch: Whereby Glaxo would only continue to
market Imigran and never launch Naramig. Although this
strategy might class all triptans as the same, negating
Zomig as a second-generation, Palmer had already made
up his mind that not launching Naramig was a waste of an
opportunity and of resources that went into developing the
medication. There was also the consideration that Zeneca
would still be able to accomplish marketing Zomig as a
second-generation triptan and leave Zeneca with an open
field.
Naramig in the U.K.
Palmer and his team chose a ‘‘Replacement’’ strategy for
Naramig. This involved ceasing all promotion of Imigran
(except to the extent of sales for patients who were already
using Imigran) and positioning Naramig as the recommended
starting place for migraine patients. Palmer felt that replace-
ment was the best way to attract triptan-naı̈ve patients and
capture the untapped market. Glaxo focused the promotion
around Naramig as a ‘‘patient-friendly’’ medication providing
patients with the best relief on the market.
The results showed that the replacement strategy met
Glaxo U.K. expectations. Naramig proved to be effective for
migraine headaches in the majority of patients. In terms of
the 90 percent untapped market, Naramig was preferred by
67 percent of previous non-triptan users. Exhibit 6 shows
worldwide sales of Glaxo Wellcome’s two triptan drugs. It is
clear that the replacement strategy thwarted the growth of
Imigran, and that Zomig and Naramig were both successful in
expanding the market.
PRODUCT POSITIONING: U.S
Mark Glackin was now faced with the same decision that
Palmer was faced with 8 ? months earlier. What was the best
strategy to market Amerge with respect to Imitrex in the U.S.
 Case 22 • Benetton • 741

EXHIBIT 6 would have to consider this difference along with the differ-
ences in the respective health care systems. Would Glaxo U.S.
Sales (£m) Triptan Revenue be successful in using DTC advertising to offer a portfolio of
700
migraine medication to various types of migraine patients, or
662.12 671.797
should the U.S. follow a similar replacement strategy as the
600 U.K. and position Amerge as the best migraine medication
539.451
500 available. Glackin considered the same 5 options for Amerge
400
positioning as Palmer had considered 8 ? months earlier for
362.346
Naramig:
300 282.588
1. Clinical/Patient Based Segmentation
200 194.304
2. Distribution Based Segment
100 6054
35 3. An Alternative to Imitrex
8
0 4. A Replacement for Imitrex
1993 1994 1995 1996 1997 1998
Imigran Zomig Naramig 5. Don’t Launch Amerge at All
DISCUSSION QUESTIONS
market? Glackin had several considerations to keep in mind
including the results of the ‘‘Replacement’’ strategy chosen 1. Why is GlaxoWellcome introducing a second migraine
in the U.K., and the effect of Zomig as a competitor. As was medication?
the case in the U.K., Imitrex had largely defined the market
2. How should GlaxoWellcome position Naramig in the U.K.?
for migraine medication and had been quite successful in cap-
turing customers. Glackin also expected that Zomig would be 3. Was the actually chosen strategy (option #4) the best deci-
launched in the U.S. prior to that of the approval of Amerge. sion?
The U.S. had recently legalized DTC advertising. Glackin 4. How should GlaxoWellcome position Amerge in the U.S.?

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 22

BENETTON
COMPANY BACKGROUND industries, and combines this know-how with the strong iden-
tity and image of world-leading sports brands that have been
Benetton was founded as a single shop in Italy in 1965. Three
incorporated through the acquisition of the Benetton Sport-
years later the company expanded into France. Eventually,
system business. These sports brand names are encompassed
Benetton spread throughout Europe and by 1979 it was estab-
under the Playlife label and include Rollerblade, Killer Loop,
lished in the United States. Benetton Group S.p.A is a unique
Prince, and Nordica. The clothing sector includes casual and
global group that is a part of a larger organization known
sportswear, consisting of the Sisley, United Colors of Benet-
as the Edizione Holding Group. This is the holding com-
ton (UCB), and Undercolors of Benetton brands, which are
pany through which the Benetton family has ownership in
mainly produced and distributed by the Automated Distri-
many different businesses including hotels, publishing, and
bution Center in Castrette, Italy, the factory that produces
real estate. The Edizione Holding Group as well as the Benet-
over 90 million items of clothing each year. There are pro-
ton Group was founded by the Benetton family, which is made
duction facilities in France and Spain as well. These finished
up of four siblings: Luciano, Chairman; Gilberto, Deputy
and packaged products are the dominant production cate-
Chairman and Joint Managing Director; Carlo, Director; and
gory for the company and are distributed directly to the
Giuliana, Director, who own and run the company as shown in
Benetton Group’s 7,000 retail stores located in 120 coun-
Exhibit 1. Luciano’s son, Alessandro, is also one of the eight
tries, of which only 55 stores are owned by the company,
Directors.
with the remaining stores independently owned and oper-
This global Benetton Group specializes in designing and
ated. The second production category for Benetton comprises
manufacturing of clothing within the textile-apparel sector of
the sports equipment and performance-wear item and a third
category encompasses items such as footwear, bags, and acces-
sories. Benetton’s overall turnover amounts to about 4,000
billion lire.
This case was prepared by Eunjung Jenny Chun, Juliet Freedman, and
Recently, in 2003, the company initiated an effort to diver-
Nicole Parker and updated by Sonia Ketkar of the Fox School of Business
and Management at Temple University under the supervision of Profes- sify away from its main clothing business by moving to acquire
sor Masaaki Kotabe for class discussion rather than to illustrate either Italian highway operator, Autostrade.
effective or ineffective management of a situation described (2003).
742 • Case 22 • Benetton

EXHIBIT 1
THE BENETTON GROUP

Edizione
80% control

Gilberto Benetton
Luciano Benetton Carlo Benetton Giuliana Benetton
Edizione Chairman/
Chairman Internal Production Activities Creative & Design
Vice-Chr. & Dir. Benetton Grp.
Italian Senator Technical Areas Operations
Financial Areas

PRICING AND LOGISTICS to think they will be happy through the purchase of the com-
pany’s products. This strategy challenges Benetton to come
In the mid-1990s Benetton adopted a strategy of price-
up with a selling theme that appeals to all consumers and
reduction worldwide. The strategy was designed to enable
overcomes local biases. Through this strategy, the Benetton
the company to guarantee its clients an ever more suitable
Group has developed advertising campaigns that are interna-
and competitive supply of products. Simultaneously, Benet-
tional, homogeneous, and characterized by universal themes,
ton decreased production costs. This combination of price and
which have been not only a means of communication but
cost reductions resulted in an 8 percent increase in both items
also an expression of the time. Through its universal impact,
produced and sold in 1994. Benetton also has an extensive
the company has succeeded in attracting the attention of the
system of outlet stores in which to sell clothing at significant
public and in standing out among the current clutter of images.
discounts, as a result of the price cuts.
In the late 1990s Benetton restructured its distribution net- Sport and Event Sponsorship
work in order to implement a new system that would integrate
One of the avenues through which Benetton communicates
a logistics system in which the warehouses are the system’s
to all of its customers is sports. Benetton Sportsystem was
junction and are part of the distribution system rather than just
renamed Playlife in 1998. This division houses the famous
places for storing facilities. The new system would eliminate
brand name product lines, (i.e. Prince), and reflects the Benet-
fragmentation of inventories across the world by concentrating
ton Group’s involvement in the sports arena, focusing on
the finished goods in three sorting centers, one in the U.S., one
the world of sports from skiing and in-line skating to ten-
in Italy, and one in the Far East. The automatic distribution
nis and snowboarding. Through the Playlife label, Benetton
system handles over 30,000 packages a day and is managed
designs sportswear clothing as well as state-of-the-art sports
by a 10-member staff, rather than a traditional system that
equipment to meet the technical demands of various athletes
requires a staff of 400. These new automated systems, along
and athletic teams. Benetton sponsors sporting teams in the
with the production facilities, have improved the efficiency
areas of basketball, rugby, volleyball, motorcycling, and until
and speed of customer service, and reduced transport costs by
recently, the Formula One racing team, which was just sold.
more than 10 billion lire in 1996. One feature that was crucial
Many young athletes acquire their first taste of sport in the
to Benetton’s success in its early years was its advanced dyeing
variety of junior clubs’ teams sponsored by Benetton. In addi-
process, whereby the finished product could be dyed instead
tion, Benetton’s success in communicating through sports can
of dyeing the yarn first. As tastes in color changed with the
be seen by its efforts in developing sport facilities. In 1985,
whims of the fashion industry, this innovative dyeing system
the sport center at La Ghirada outside of Treviso, Italy was
allowed Benetton to establish a customized production system
built and is used today by all enthusiasts. Also, the Palaverde,
that keeps up with the latest market trends.
a multifunctional complex, was opened in 1983 and is used for
COMMUNICATIONS sporting events as well as concerts, shows, and cultural activi-
ties with a capacity for a 6,000-member audience. Playlife, in
Benetton’s communications strategy was developed as a result
essence, is the passport to the Benetton world, a new way of
of the company’s desire to produce images of global concern
embracing every-day life in the spirit of sport.
for its global customers. The communication strategy targets
issues rather than clothes as the leading player, with a portion Colors Magazine
of the advertising budget devoted to communicating themes
relevant to young and old people worldwide. The company Benetton communicates through its award winning, bimonthly
claims, ‘‘We realized some time ago that we had a unique magazine, Colors. It is distributed in six bilingual editions in
tool for communicating worldwide, as we are present in 120 Europe, the United States, Latin America, and Asia.
countries, and that it would be cynical to waste it on self-
Fabrica Project
serving product promotion. We trusted in the intelligence
of our customers worldwide and decided to give space to The company also communicates through the Fabrica project,
issues over redundant product claims.’’ Benetton believes it which is a workshop environment and a center of communi-
is important for companies to take a stance in the real world cations for a group of twenty students selected from countries
rather than use its advertising budget to encourage consumers around the world. Research into future trends and new ideas
 Case 22 • Benetton • 743

is conducted among the students, who actively research the the fiftieth anniversary of the Declaration of Human Rights,
field of communications. which was approved by the United Nations General Assembly
on December 10, 1948.
Image Advertising
Unlike the traditional advertising for most companies, Benet- EXHIBIT 2
ton’s images do not have a copy or a product, only the HIV POSITIVE
company’s logo. The ads do not tell an individual to buy Benet-
ton clothing or even imply this! Their ads simply attempt to
promote a discussion and create awareness about global issues
that might be overlooked if conveyed through other channels.
However, as far as their products are concerned, the company
advertises through its many strategically placed stores, its cat-
alogues, and fashion editorials that display them directly to
the consumer. Also, there are public relations offices in all of
the countries that have a liaison with fashion editors. These
offices utilize traditional marketing techniques to ensure the
products receive the necessary exposure or sales personnel,
among other criteria.

What is image advertising? Image advertising has evolved

into a form of lifestyle marketing. The fashion industry targets
its image-oriented advertising into a brand that can match
every type of lifestyle, such as Calvin Klein is hip, Ralph
Lauren is rich, and Benetton is highly controversial. Adver-
tising industry experts claim that image advertising is part of
a master plan to get customers to ‘‘buy-in’’ to a lifestyle, first
connecting through a psychological/aspirational level and then
on a product level. Similarly, this has been achieved through
advertising in the automobile industry.
Within the realm of image advertising falls the concept of
emotional branding. Emotional branding, sometimes referred
to as shockvertising, is a form of image advertising intended to
sell images rather than the products themselves, by appealing
to a customer’s emotions. This targets other dimensions for
attracting consumers, not through the functional aspects of
products, but through the emotional aspects, which is what
branding is all about.
Campaigns
Benetton’s advertising campaigns have centered on social
issues and current worldwide issues such as AIDS, peace,
war, and death. Many of their communications initiatives sup-
port international humanitarian associations. For example,
Benetton was part of the first global project to redistribute
clothing to people in need in 1993; it was called the ‘‘clothing
redistribution project’’ and was assisted by the International
Federation of the Red Cross, as well as other groups. This
campaign also utilized the shock value of imaging, as Luciano
Benetton appeared nude in these advertisements. As part of
their AIDS campaign, the 1994 ads showing the words ‘‘HIV
Positive’’ tattooed on a person’s arm, abdomen, and backside
are additional examples of the shockvertising conducted by
Benetton (see Exhibit 2).
Those ads were used as metaphors for the more exten-
sive branding practiced throughout society toward those who
are different. With those images, Benetton wished to high-
light not only the main channels through which HIV can
be transmitted, but also the dangers of stigmatizing certain
social groups and their lifestyles. In 1998, a human rights
campaign was initiated as a result of a United Nations pro-
posal to launch a world communications exercise to mark
One of the ads for this campaign showed images of chil-
dren of all colors and ages to emphasize that ‘‘every child shall
be entitled from his birth to a name and a nationality’’ (see
Exhibit 3). In addition, Benetton’s recent campaign during
2000 addresses capital punishment by showing images of some
of America’s death row inmates. This campaign aims to show
the public the reality of capital punishment, so that no one
around the world will consider the death penalty as just a
distant problem or as news that occasionally appears in the
media.
EXHIBIT 3
UNITED NATIONS
The campaigns have won numerous awards, prizes, and
acclaim in all of the countries in which the company is present;
however, they also have aroused various strong reactions.
Benetton is aware of the controversy that surrounds the images
of these campaigns. However, they believe that all worthwhile
stances will have critics and supporters. Benetton hopes that
people will move away from the discussion of whether or not
a company is entitled to show its point of view in its advertis-
ing campaigns, to a discussion of the issues themselves. This
has occurred in some countries already, which supports the
company’s goal of becoming the vehicle for discussion rather
than its focus.
744 • Case 22 • Benetton
MARKET SHARE
Americas
During the 1980s Benetton expanded aggressively into the
United States, opening some 500 stores and outlets. This
rapid expansion caused numerous management catastrophes
resulting in unhappy retailers and declining revenues. Specifi-
cally, Benetton encouraged retailers to open stores that were
located too close to one another which subsequently led to
self-cannibalization. Additionally, advertisements such as the
one showing the U.S. President with AIDS lesions caused
many loyal American customers to boycott Benetton stores.
In addition to operational blunders, Benetton was also guilty
of making fashion errors as well. In the mid 1980s, their largest
selling items in Europe were their brightly colored sweaters.
When the sweaters were introduced into the United States
as the company’s signature product, it was a disaster. Subse-
quently, Benetton had to readjust their shipments and designs
to fit North American tastes. A combination of this issue
along with overexpansion led many retailers in the late 1980s
to take legal action against Benetton, charging that they had
encouraged too many stores to be built too close together and
failed to supply them adequately.
By the early 1990s sales in the United States had decreased
sharply. Benetton was producing clothing targeted to a
younger generation of 18- to 23-year-olds in the U.S.; how-
ever, they were not accustomed to paying the higher prices
charged by Benetton. This was a generation that was brought
up on GAP pricing strategies, which were lower and more
affordable than Benetton, and therefore, found Benetton’s
prices too high for their budget, while others were unaware
that Benetton also sold designer dresses and suits.
After having 350 of its 500 stores closed by 1995, Benetton
grew increasingly aware that they were targeting the wrong
market in the U.S. To combat the negative sales growth,
Benetton began offering a more diverse clothing line and
installed a point-of-sale system, which allowed the stores to
feed information on sales back to the Italian headquarters. In
addition, in 1998 Benetton began offering its first intraseasonal
collections to increase its ability to respond more quickly to
changing market trends. By 1999, the point-of-sale system had
proven to be such a success that they had begun to test an
upgraded system that would report not only the item sold but
also its size and color.
In 1997, Benetton made a strategic move by acquiring 57
percent of the Sportsystem division from Edizione, and later
purchased the remaining shares in 1998. This acquisition pro-
duced a large boost for U.S. sales due to its large market
for sporting goods equipment. To support this latest acqui-
sition, they launched a $27 million marketing campaign (see
Exhibit 4 for sales figures).
An attempt to gain a larger share of the U.S. market
was made in 1998 when Benetton signed a deal to form a
joint venture with Sears Roebuck and Company to design a
line of less expensive clothing that would be sold in Sears’
department stores. The joint venture was part of a larger
strategy to expand in the United States without having to
open new Benetton stores. Sears and Benetton introduced
last summer a new line of junior’s, children’s, and men’s
apparel, called Benetton USA, in 450 Sears stores; the line
was expected to generate $100 million in sales in its first year
and draw in younger, more cost-conscious customers. The deal
fell through however, when Sears pulled the clothes off the
shelves due to consumer complaints and boycotts regarding
Benetton’s anti–death penalty campaign in February 2000.
Overall, Benetton’s strategy in the United States has not been
very successful. Sales in North America fell by 17 percent
by the end of the third quarter of 2002 as compared to that
in 2000.
EXHIBIT 4
SALES BY BRAND, 2001
2001
United Colors of Benetton
Sisley
Rollerblade
Prince
Nordica
Killer Loop
Playlife
Other(intimate, sleepwear, swimwear, etc.)
In addition to North America, Benetton also began to
establish a presence in South America and the Dutch Antilles
(Saint Maarten) during the mid-1980s. This move was a strate-
gic success, for a number of reasons. Much of South America
still held strong bonds with Europe, such as consumers’ tastes
in fashion. Countries such as Brazil, Argentina, and Colombia
embraced the Italian label and therefore, Benetton had found
a market full of loyal customers. However, Latin America was
hit severely by an economic recession during the late 1990s,
which reflected negatively on both clothing as well as sporting
goods sales in most of South America.
Europe
During the 1980s Benetton flourished throughout Europe.
Sales had increased at a double-digit growth rate and during
some years even reached 25 percent. However, much of that
changed during the 1990s when sales growth began to decrease
down into the single digits. The decline in sales, specifically
in 1995, can be attributed to a number of factors, including
the European recession, which caused sales growth to decline
sharply in certain markets (see Exhibit 5).
Germany, the market, that suffered the most during the
mid-1990s, was also Benetton’s largest market. In 1994, Benet-
ton released two of its most controversial campaigns, the
‘‘Croatian Soldier’’ and ‘‘HIV Positive.’’ Both campaigns fol-
lowed Benetton’s mission to support social causes and increase
awareness on global issues but both also managed to provoke
strong ill-will feelings toward the company, whose reputa-
tion was already faltering due to the recent store closings
in Germany. By late 1994, retailers in Germany began to
notice a decline in sales and profits. Claiming the decrease in
operating profit was due to self-cannibalization, extreme price

EXHIBIT 5
SALES BY REGION
SALES BY REGION
$3,000,000,000
$2,500,000,000
$2,000,000,000
$1,500,000,000
$1,000,000,000
$500,000,000
$0
89
90
91
92
93
94
95
96
97
98
99
2,000
2,001
cuts, and tasteless advertising (which was causing boycotts in
Germany), many German retailers began to publicly criticize
Benetton and two store owners even refused to pay for their
merchandise. In mid-2002, a German high court barred the
company’s HIV advertising campaign and referred to it as
‘‘anti-competitive.’’
Benetton, however, attributed a decline in sales to a com-
bination of many different factors such as the European
recession and poor management on behalf of its franchises.
Benetton did acknowledge that their pricing strategy did result
in price cuts, but justified it by claiming that they were neces-
sary in order to maintain market share. In addition, Benetton
also sued these two store owners for nonpayment of the mer-
chandise ordered. Both store owners countered the lawsuit,
claiming Benetton was liable for the loss of sales, which they
felt, was attributed to Benetton’s advertising strategy. The
store owners lost the case and were required by the court to
pay Benetton $600,000 for the merchandise ordered. Overall,
1994 was not a good year for German Benetton retailers,
as their sales dropped 16 percent or $35 million in 1994. To
counteract the negative sales growth in Germany, Benetton
began restructuring their sales network to create a network
that would be more in tune with their guiding principles of
business sense, creativity, and dynamism. This entailed replac-
ing many of the smaller outlets with bigger multiproduct stores
as well as recruiting new franchisees.
Also in 1994, Italy and France were embroiled in contro-
versy over disputes with Benetton. Santomo Alligliamento,
one of the largest operators of Benetton stores in Italy, sued
Benetton for late shipment of garments, as well as for not
changing their product lines as frequently as their competi-
tors. Despite this, sales still increased in Italy, increasing
slightly less than 4 percent in 1994 and 13 percent in 1995.
During this same time period Benetton was forced to pay
$28,500 to AIDS patients in France, after a Paris court ruled
that the ‘‘HIV Positive’’ campaign was ‘‘an abuse of freedom
of expression and a provocative exploitation of suffering.’’
Despite negative publicity surrounding lawsuits in some
European countries, Benetton still managed to achieve a sales
growth rate of 34 percent. The opening of megastores in every
European capital by the end of 1995 supported this growth.
The strategy of the megastore is to gain a larger share of the
market by offering clothes for the entire family. By 1999, on
Case 22 • Benetton • 745
Europe
Americas
Other
average, the existing megastores each occupied 6,000 square
feet; however, some megastores are much larger such as the
Milan store, which has over 32,000 square feet. Benetton,
which had around 7000 franchisees all over the world, plans to
continue this strategy in 2003 to move toward directly oper-
ated stores, mainly megastores with a lot of retail space. The
company attributes the need for this change to the changes
in consumer behavior, which indicated that customers need
more space and color and light in the retail store. Benetton
plans to have 300 megastores around the world by the end
of 2004.
In 1998, Europe generated 70.7 percent or $1.69 billion
of Benetton’s volume. Industry analysts had predicted that
European consumer spending would increase between 1998
and 2000. Estimated consumer spending was expected to
increase by 2.4 percent in Italy, 2.5 percent in Germany,
and 2.3 percent in France. However, contrary to prediction,
in 2001, Europe generated only 68.7 percent of total vol-
ume.
Other Countries
Benetton’s presence in developing nations grew heavily in the
mid-1990s. In line with their strategy to conquer new mar-
kets, Benetton opened new stores in Angola, Ethiopia, Nepal,
Pakistan, Syria, the Ukraine, and Vietnam, making Benetton
the first Western company present in these local markets. In
addition, 50 new stores were opened in China and the number
of stores in Korea reached 100 by the end of 1994.
In the mid-1990s, Asia was seen as Benetton’s largest
opportunity for growth, especially since its performance in
America was hardly satisfactory. However, sales began to
decline in the late 1990s as a result of the Asian financial crisis.
In 1998, the Far East accounted for 13 percent of total sales,
with Japan accounting for 7 percent or $168 million. This is
a significant drop from 1997 in which Japan alone accounted
for 17 percent of Benetton’s total sales. The decline is largely
a result of significant damage to the sales of Benetton’s Sport-
system division, which relies heavily on Asian markets. In
2001, Asia’s contribution to total revenues fell to 9.3 percent.
Korea was another market significantly hit in 1998, where
the entire market might have been lost if Benetton had not
reacted quickly. By setting up a manufacturing and distribut-
ing joint venture with a local Korean operator, they were
746 • Case 22 • Benetton
able to circumvent a complete loss of their Korean market.
However, the decrease in Asian clothing sales had little impact
on the company’s overall clothing sales, mainly attributable
to the fact that Asia accounted for only 15 to 17 percent of
Benetton’s global clothing sales. Profits would have risen 33
percent rather than the actual 18 percent if Sportsystem had
not suffered such a loss from the Asian financial crisis.
However, in spite of the financial crisis that occurred in the
late 1990s, Benetton announced in 1998 its plans to open three
new megastores in Japan beginning in the spring of 2000. The
strategy was based on a dip in property prices, which would
allow Benetton to buy property in Japan relatively cheaper
than in the past.
OPPORTUNITIES
Communication Sources
Europe’s Internet commerce industry is starting to pick up,
following the lead by the United States, where over 70 per-
cent of the world’s e-commerce business took place over the
past year, according to market research company International
Data Corporation. The research firm Jupiter Communications
reported online retail sales in Europe would reach $3.3 billion
in 2002, up from $165 million in 1998. In December 1999,
when Benetton announced it would begin selling products on
the Internet, its share surged nearly 13 percent, resulting in
its largest one-day rise in more than one year. Online sales
will allow the company to access markets where it has low
penetration and where e-commerce is more developed, such
as in the U.S.
In India, Benetton’s advertising is concentrated on a
renewed focus of communication. Benetton’s image in India
was considered a discounted brand, since they usually limited
their advertising to only two end-of-season sales. However,
recent television commercials were received positively by both
franchisees and consumers. This kind of positive feedback
could result in a new opportunity for Benetton by focusing
more on media channels such as television and radio, rather
than billboards or magazines.
In addition, Benetton had great success with their two-
tiered approach, specifically with the launch of their Sportsys-
tem division. This approach was taken in order to gain a larger
share of the U.S. market without having to abandon their
traditional image campaigns. By allowing their U.S. retailers
more flexibility when choosing which advertisements to use
for a selected campaign, they were able to circumvent any
potential loss of market share and also retailer dissatisfac-
tion. Benetton could use this strategy when developing future
campaigns.
Japan
To increase sales in the future, the U.S. and Japan should lead
the way as an opportunity for increasing Benetton’s total rev-
enues, even though the company expects Italy and Germany
to remain its top two markets. Japan is currently recovering
from a financial crisis, which should lead to increased oppor-
tunities for future growth in Benetton’s sales and profits. The
Asian financial crisis dramatically affected sales of Benetton’s
sporting goods line in Japan, causing a 10 percent drop in sales
in 1998, and 17 percent in 1997. This required Benetton to
acquire more sportswear revenues in the U.S., which produced
only 16 percent, or $384 million, of Benetton sales in 1998 and
15.6 percent in 2001.
The total Japanese market for apparel was estimated at
approximately $35 billion as of 1999. The apparel market in
Japan was growing at 10 to 15 percent annually until 1996,
despite a slow economy and a stagnant domestic apparel
market since the early 1990s. In particular, Japan’s apparel
imports enjoyed a remarkable increase of a 15 to 20 per-
cent annual growth until 1996. Japan’s gross domestic product
(GDP) registered a real growth rate of 0.9 percent in 1997.
This was the first time in three years for the figure to fall below
one percent and was the lowest level among major devel-
oped nations. According to 1997 statistics compiled by the
Ministry of Finance, the major countries from which apparel
is imported and their respective percentages of the import
market are: China, 69.4 percent; Italy, 8.2 percent; Vietnam,
3.6 percent; Indonesia, 2.5 percent; and the United States,
2.4 percent. The high market share from China and Viet-
nam is due to Japanese manufacturers’ increasing use of their
joint-venture sewing mills in these countries, where lower-cost
labor is available. Imports from Italy were stable over time
due to the deeply implanted good brand image of Italian
fashion among Japanese consumers. Italian apparel compa-
nies are currently trying to regain their 1980’s position in the
Japanese market through the creation of classic-casual types
of women’s wear at reasonable prices. Benetton, looking to
capitalize on its Japanese customers, has targeted this market
as an opportunity for future growth based on economic and
cultural aspects such as their loyalty to Italian brands and
the country’s growing economic status. Since Japan is a high
context country, Benetton should see this as an opportunity
to extend on their already strong relationship as Japan moves
into a period of economic growth.
France
There appear to be numerous opportunities for companies to
successfully penetrate the French market to gain market share.
The size of the apparel market in France has been growing
over the last three years, as well as increasing amounts of the
total exports and imports. Benetton could capitalize on this
growing demand for apparel among the French population.
APPAREL MARKET IN FRANCE
(MILLIONS U.S. DOLLARS)
1997 1998 1999
Total market size 37,739 37,850 38,228
Total local production 15,130 14,800 14,948
Total exports 22,260 22,295 22,740
Total imports 29,043 30,164 31,068
Total imports from U.S. 1,452 1,206 1,218
Exchange rate: USD 1.00 FF 5.75 FF 6.00 FF 6.10
Belgium
Consumer spending in Belgium is picking up after over five
years of flat, and even depressed, consumer demand levels.
Consumption grew 3.6 percent in 1998, due to increases in real
income per household and consumer confidence. Economic
forecasts are pointing to steady growth of about 3 percent for
 Case 23 • Two Dogs Bites into the World Market: Focus on Japan • 747

APPAREL MARKET IN BELGIUM DISCUSSION QUESTIONS

(MILLIONS U.S. DOLLARS) 1. How has Benetton’s uniform communications strategy
1997 1998 1999 translated into sales and profit in different parts of the
world?
Total market size 2,890 2,952 3,098 2. Does its pricing strategy reflect positively on Benetton’s
Total local production 1,824 1,863 1,956 net profit?
Total exports 986 1,008 2,200 3. Should Benetton restructure its distribution and man-
Total imports 2,052 2,097 1,058 ufacturing network in order to hedge foreign currency
Total imports from U.S. 81 82 85 fluctuations?
Exchange rate: $ = BEF 35.7 36.3 37 4. Should Benetton continue to focus on increasing market
share in the U.S. by focusing on department store growth, or
1999 and 2000. There is a continued strong market interest increasing store expansion? In addition, should it be focus-
for American sporting and leisure apparel, as American styles ing more on ‘‘crisis management’’ rather than expansion in
are popular and designer and branded products are less price the aftermath of the death penalty campaign?
sensitive in Belgium. Major competitors of the local Belgian 5. Should Benetton restructure the communications strategy
markets come from manufacturers and designers in France, to incorporate both the two-tiered approach and a more
Germany, and Italy. For low-budget clothing and mass dis- country-tailored positioning strategy?
tribution items, low-cost producers in the Far East, such as 6. Benetton’s advertising budget is only 4 percent of their
China, Thailand, and Indonesia continue to provide the bulk sales. This is a rather low number, especially consider-
of imports. Benetton has the opportunity to gain market share ing that most of this budget has been spent on developing
in this country by promoting their sportswear and leisure their image advertisements. Should Benetton increase their
apparel that appeal to this market’s consumers. As you can advertising budget, and if so, should more go to traditional
see by the following table, Belgium’s market size is growing, clothing and sports equipment advertisements?
as is its local production figures. Although, the total imports
declined in 1999, Benetton still has the capacity to formalize a
joint venture with local retailers and set up their distribution
system to begin reaping profits.

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 23

TWO DOGS BITES INTO THE WORLD MARKET: FOCUS ON JAPAN

CREATION OF ‘‘TWO DOGS’’ activities, instead of investing in a costly commercial brewing
and bottling facility.
On a cool winter day in Adelaide, South Australia, a city with a
TWO DOGS quickly gained market acceptance, firstly
population of 1.1 million, Duncan MacGillivray found himself
because consumers loved the new taste sensation of ‘‘brewed
in a conversation with his neighbor who had too many lemons
alcoholic lemonade,’’ but also because it filled a real market
for which he was trying to find a use. MacGillivray, who owned
niche for a ready-made beverage similar to beer but with an
a pub in the city, decided to brew the lemons into an alcoholic
easy flavor profile. TWO DOGS exceeded initial expecta-
drink to serve as a refreshing alternative to draught beer. Thus
tions when it reached domestic sales of over 400,000 cases
was born the world’s first commercial brewed alcoholic lemon
in the first twelve months, and extended its presence to the
drink. The brew, which became known as TWO DOGS
whole of Australia within one year of launch.
after a joke, became a highly popular drink and was soon
The success of TWO DOGS attracted competitors, who
made available on tap (draught) in pubs all around Adelaide,
sought to emulate TWO DOGS and capitalize on the newly
as shown in Exhibit 1.
created and rapidly growing consumer niche. The first com-
The popularity of the drink quickly spread by word of
petitor came in late 1994 from Australia’s largest brewer
mouth. In response to the dramatic increase in sales, the
(Fosters); the product ‘‘Sub Zero’’ was a sweetened alcoholic
company commenced bottling the drinks in 1994 to increase
soda targeted at young adults. By 1995, there were dozens of
its product availability in the distribution channel. To meet
different sweet alcoholic drinks, all brightly colored, exotically
the demand, TWO DOGS was produced under contract
flavored with catchy names including ‘‘Z’’, ‘‘KGB’’, ‘‘Cactus’’,
by a local brewery in Adelaide. This enabled the com-
‘‘Ruski’’, ‘‘DNA’’, shown below in Exhibit 2.
pany to focus its resources on marketing and brand-building
INTERNATIONAL EXPANSION
This case was prepared by Professor Amal Karunaratna of the University In the face of fierce domestic competition, the company Two
of Adelaide, Australia for class discussion rather than to illustrate either Dogs International (‘‘TDI’’) commenced an international
effective or ineffective management of a situation described (2003).
748 • Case 23 • Two Dogs Bites into the World Market: Focus on Japan
EXHIBIT 1
CREATOR DUNCAN MACGILLIVRAY WITH, GLASS OF ORIGINAL
DRAUGHT TWO DOGS
EXHIBIT 2
EARLY COMPETITORS IN AUSTRALIA
expansion program in 1995. Its first market entry was into
the United Kingdom. In the Northern hemisphere summer of
1995, riding on the back of the close historical and cultural
connections between Australia and the U.K. (including com-
mon language and similar legal and regulatory systems), the
first eight shipping containers of TWO DOGS arrived in the
U.K. TDI initially adopted a direct export strategy, selecting
and appointing a relatively small but well-established English
cider maker as its exclusive distribution partner. The appear-
ance of TWO DOGS incited massive consumer interest,
such that it was impossible to meet the surging demand given
the six-week shipping time from Australia. Therefore TDI
quickly moved to a licensing strategy, allowing TWO DOGS
to be produced in the U.K. Within six months of its official
launch in May 1995, TWO DOGS outperformed the initial
annual sales target of 300,000 cases, and went on to achieve
one million cases in 1996.
Following its U.K. market success, and utilizing its pro-
duction base within the European Union, TWO DOGS
commenced export from the U.K. into continental Europe
including Denmark, Finland, France, Germany, Italy, the
Netherlands, Norway, Sweden, and Switzerland.
Around the same time, in June 1996, TWO DOGS
commenced its U.S. market entry. Learning from the U.K.
experience and also due to high import duty on alcoholic bev-
erages, TDI adopted a licensing strategy incorporating local
production from the start. By 2001, with annual sales around
the one million cases, TWO DOGS was voted as one of the
‘‘Hot Brands’’ in the U.S. by Impact magazine.
The third key market in TDI’s international expansion
program was Japan. TDI realized it needed distribution
strength to be successful in Japan and in 1997 formed
an exclusive import and distribution agreement with Kirin-
Seagram, a joint venture between Japan’s leading brewer
 Case 23 • Two Dogs Bites into the World Market: Focus on Japan • 749

Kirin and international spirit company Seagrams. A direct
export strategy was possible due to the relative proximity
of Japan to Australia, only two weeks away by ship. Brand
awareness was built gradually, first in Tokyo bars only, then
expanding nationally. By 2000, TWO DOGS ’ distribu-
tion had extended from bars into most major convenience
stores, and achieved the one million case sales benchmark
in 2001.
TWO DOG’S PATH TO INTERNATIONALIZATION
TWO DOGS’ rapid internationalization is rare for a small
company. By 1997 TWO DOGS had built a product pres-
ence in over 35 countries serviced by production across three
continents, for which a detailed list is shown in Exhibit 3.
Overall, TDI has been able to achieve its rapid expansion
by combining direct export strategies with licensed produc-
tion within some key markets, alleviating the need to invest in
capital equipment by utilizing its partners’ excess production
capacity.
TWO DOGS strive for internationalization can be
attributed to MacGillivray’s entrepreneurial nature combined
with his background in commodity trading and shipping busi-
nesses. As with most entrepreneurial activities, TDI’s early
expansion took place with limited capital.
In February 1997, Pernod Ricard acquired TWO DOGS,
ensuring a strengthened resources base that has allowed TDI
to pursue its global expansion and brand-building activities.
By 2001, the retail value of the TWO DOGS brand’s sales
approached A$100 million, the majority being in overseas
markets.
PRODUCTS AND BRANDING
Product
TWO DOGS is a fermented beverage made with real
lemons. No alcohol or spirit is added at any stage during
the brewing process as all the alcohol is derived from the
fermentation. While the flagship is the Australian Original
Lemon Brew, other flavors have been developed to expand
the range including Orange, Apple, Raspberry, and Blackcur-
rant brews, all with around 4 to 5 percent alcohol content.
TWO DOGS is packaged in a variety of single serve packs
to suit the market conditions with bottle sizes ranging from
250 ml to 355 ml and draught product is still available in
selected markets. Examples of some TWO DOGS products
are shown in Exhibit 4.
Following its unusual name, a key feature on the pack-
aging is the distinctive TWO DOGS brand logo, shown in
Exhibit 5. Depicting two bulldogs, the logo communicates fun,
honesty, and companionship to consumers, and is used as a
vehicle to position the brand as irreverent and mischievous,
capturing the perceived larrikin nature of Australians.
The Alcoholic Fruit Beverage Market
The alcoholic fruit beverage market seems to have emerged
less than a decade ago. With its sweet flavor along with mod-
erate alcohol content, core consumers were young adults and
women who did not like beer or the taste of traditional wine
and spirits. In particular, the young adults to whom these
drinks appeal often demonstrate low brand loyalty and switch
brands readily, in search of novelty. This type of lifestyle

EXHIBIT 3
TWO DOGS INTERNATIONAL NETWORK IN 1997
Australian production serves U.K. production serves markets
opportunities in: Europe:
Australasia, Asia and Middle East Great Britain
New Zealand Scotland
China Ireland
Hong Kong Austria
Japan Bermuda
Singapore Cyprus
Taiwan Denmark
Malaysia Finland
Thailand France
United Arab Emirates Germany
Bahrain Gibraltar
Sri Lanka Greece
Papua New Guinea Italy
Guam Malta
Netherlands, Belgium, and
U.S. production serves North and Luxembourg
South America: Norway
United States Spain
Canada Sweden
Brazil Switzerland
750 • Case 23 • Two Dogs Bites into the World Market: Focus on Japan

EXHIBIT 4
EXAMPLES OF TWO DOGS PRODUCT RANGE, IN 330 ML
AND 250 ML BOTTLES

product is highly sensitive to trends and aspirations, and EXHIBIT 5

therefore the marketing mix needs to be adapted to suit local THE DISTINCTIVE TWO DOGS BRAND LOGO
market conditions. Consumer preference is based on percep-
tions; hence, branding is critical to product differentiation.
The intensity of global competition is high. Barriers to entry
are low, switching costs are low, and consumer preferences
fluctuate within trends, so there is good reason to believe that
individual product life cycles within this category are likely
to be short. For example, wine coolers were highly popular
in the 1980s but are now relegated to a niche market in the
early 2000s. The threat of substitutes for any single brand or
product is extremely high.
ENTRY TO THE JAPANESE MARKET
Pre-Entry Research
TDI’s market selection decision in the UK and the USA
was based on perceived cultural similarity to Australia, all People and Culture
being modern western English-speaking countries, so appro-
priate market positioning was readily understood. Expansion Japan has a highly urbanized population of approximately
into Japan, however, was a different proposition in terms of 127 million. Over 44 percent of the population lives in major
unknown culture, laws, trends, lifestyle, and beverage choices cities such as Tokyo, Osaka, and Nagoya. Japan is a homoge-
and therefore all activities needed to be based on considerable neous, affluent society, with an aging population and one of
formal market analysis. Prior to market entry in Japan, TDI the longest life expectancy rates in the world (83.99 years for
spent more than eighteen months conducting market research. women and 77.1 years for men).
Japanese people respect long-term relationships, polite-
Preliminary Market Research ness, and collectivity whereas Australians tend toward indi-
In order to evaluate the initial feasibility of entering the vidualism. On the other hand, modern Japanese are great
Japanese market and assess the market potential, TWO travellers and the young adult consumers in particular have
DOGS first conducted a preliminary assessment that embraced western culture and influences such as fast food,
was based on gathering data on the macro- and micro- fashion, and music entertainment1 and lifestyle aspirations.
environment including general economic outlook, political TDI used these data to estimate the size of its potential
stability, population size, age of the population and wealth market in Japan. By segmenting its target market predomi-
distribution, and industry trends. nantly on the basis of consumer age, the target market size
 Case 23 • Two Dogs Bites into the World Market: Focus on Japan
within 20 to 30 age group was estimated to be about 19 million2
and accounted for 15 percent of the total population of Japan.
Economy
Japan is the world’s second largest economy, after the United
States. The Japanese economy is 12 times that of Australia but
has remained in a prolonged state of recession for the last few
years. Private sector demand remains sluggish due to uncer-
tain economic times. Despite stimulus packages introduced
by the government, Japan’s economy remains stagnant, which
has led to fundamental changes in business structure such as
the breakdown of traditional interlinked (keiretsu) business
relationships.
Nevertheless, Japanese consumers’ per capita income is
among the highest in the world (A$ 70,000 in 1999)3 . The rel-
ative size of the Japanese market (in terms of population and
affluence) coupled with its small agricultural resource base
presents a good opportunity for food and beverage exporters.
Japan is Australia’s largest foreign trading partner with mer-
chandise exports from Australia worth A$21.3 billion in 2000,
and the composition becoming increasingly diversified with
processed foods and beverages4 .
Therefore, despite the fact that Japan’s economy was in a
state of long-term recession, TDI determined that per capita
income was sufficiently high that consumers would be able to
afford foreign luxury products, such as TWO DOGS.
Political and Legal Environment
Overall, Japan has a high level of political stability. Fur-
thermore, although the Japanese government has little direct
involvement in the operation of the private sector, through
its ministerial bureaucracies, it maintains tight supervision of
firms via regulation and mandatory administrative guidance5 .
However in regards to trade barriers, the deregulation trend
is in favor of foreign exporters; for example, the customs duty
will be abolished on beer and low malt effervescent alcoholic
beverages in 2002.6
TDI obtained specific information regarding the customs
classification of its product and the applicable customs duties
and liquor taxes in Japan, in order to calculate whether the
landed unit cost of its product appeared commercially viable.
Industry Trends
Finally TDI considered broad consumption trends especially
of alcoholic beverages. TDI found that from 1990 to 1997,
beer consumption was declining, spirits were flat, while wine
was growing rapidly from a small base. These changing con-
sumption patterns indicated that drink trends were shifting,
and could indicate an opportunity for low alcohol drinks such
as TWO DOGS.
Primary Research
Having identified that Japan was an attractive market, TDI
needed to assess whether the TWO DOGS product would
appeal to Japanese consumers. The first step was to attend
Foodex in Tokyo, the world’s largest food and beverage trade
show, which offered the opportunity of conducting a large
number of taste trials directly with Japanese consumers of
various ages, gender, and socioeconomic status. This initial
consumer feedback was positive; most people seemed to like
the taste of TWO DOGS.
• 751
Based on this, TDI sought a local company with a well-
established network to distribute TWO DOGS in Japan. The
formal selection process included an initial search, cost and
risk analysis before a decision was made. After investigation,
TDI identified the major companies in the Japanese liquor
industry, and through its international contacts arranged an
introduction to Kirin-Seagram Ltd, a subsidiary of Kirin Brew-
ery—Japan’s leading beer company. Aside from its strong
distribution capability, Kirin-Seagram was evaluated highly
for its marketing expertise in the liquor industry, as it was
clear to TDI that a very close understanding of the Japanese
consumer would be necessary for success.
Together, TDI and Kirin-Seagram carried out more exten-
sive research based on consumer surveys and focus groups of
different age groups. The research focused on taste, pack-
aging, and labeling. Feedback from the research showed
positive reactions from respondents. They liked the taste and
responded to the TWO DOGS logo positively as ‘‘cute’’.
Based on this research, TDI proceeded confidently to launch
TWO DOGS in Japan with Kirin-Seagram as its exclusive
distributor in 1998.
Secondary Research
Even after launch, ongoing product testing and consumer sur-
veys were conducted to ensure the brand continued to retain its
appeal with Japanese consumers, and to evaluate the effective-
ness of advertising campaigns. Consumer surveys conducted
soon after launch found that Japanese consumers found the
350 ml TWO DOGS bottles too large; TDI reduced the
bottle size to 250 ml, and even though the smaller bottle was
sold at the same price, paradoxically, sales increased.
In addition, brand-tracking data were periodically gathered
using independent research companies to conduct surveys
every six months. Consumers would be surveyed on a range of
dimensions including their level of brand awareness (whether
they had heard of TWO DOGS) and advertising awareness
(whether they could recall seeing a TWO DOGS ad), as
well as their recent drinking habits and purchase intentions.
Consumers’ awareness of the TWO DOGS brand rose from
40 percent in April 2000 to over 80 percent by June 2001,
demonstrating the success of an intensive national television
campaign that was run over the same period. From a com-
parison of the same data collected on other alcoholic drinks,
it was possible to also evaluate whether TWO DOGS was
increasing its awareness and purchase intention relative to
competitors, which serves as an indicator of improving market
share and market positioning.
ADAPTATION OF THE MARKETING MIX
Product
The TWO DOGS Lemon Brew product required no adap-
tation to meet the requirements of the Japanese market.
Japanese consumers liked the taste, appreciated the unique
concept of a naturally fermented lemon brew, and the for-
mulation met the necessary regulatory requirements for its
liquor classification. Later, after Lemon Brew was established,
other flavors of TWO DOGS were developed or adapted
specifically for Japan. The first, launched in 2001, was ‘‘TWO
DOGS Blackcurrant Brew’’ which needed to be renamed
‘‘Cassis Brew’’ as the Japanese did not recognize the word
752 • Case 23 • Two Dogs Bites into the World Market: Focus on Japan
‘‘Blackcurrant’’. Then ‘‘TWO DOGS Lychee Brew’’ was
developed specifically to appeal to the particular tastes of
Japanese consumers.
Packaging
Notwithstanding the inclusion of Japanese language on the
labels, there are two areas in which TWO DOGS packaging
had to be substantially adapted in order to succeed in the
Japanese market. The first was the bottle, which included the
adjustment of bottle size from 350 ml to 250 ml as well as a
change from its traditional green glass to clear glass bottles,
which are considered easier to recycle in Japan. The second
was a series of changes to the bottle cap: the original prod-
uct had a crown-seal cap (like beer) which requires a bottle
opener. When TWO DOGS distribution was extended to
the off-premise, the cap was changed to a ‘‘ring-pull cap’’
which is able to be opened by hand and therefore more con-
venient. However Japanese consumers were unfamiliar with
ring-pull caps and found them difficult to open, so finally the
product was changed to a ‘‘screw cap’’ as found on soft drinks.
Exhibit 6 shows the different TWO DOGS ’ bottles and
caps sold in Japan at various times.
Place
The distribution channel for liquor can be divided into ‘‘on-
premise’’ and ‘‘off-premise’’. ‘‘On-premise’’ refers to outlets
in which consumers buy and consume the product in the same
place (i.e., on the premises) such as pubs, discos, bars, and
restaurants. ‘‘Off-premise’’ refers to retail stores in which the
products are consumed away from the point of purchase such
as convenience stores, specialty liquor stores, and supermar-
kets. In Japan, the TWO DOGS brand was established in
the on-premise exclusively for the first eighteen months after
EXHIBIT 6
PACKAGING CHANGES FOR JAPAN (FROM LEFT TO RIGHT):
350 ML WITH CROWN CAP, 250 ML WITH CROWN CAP, 250 ML
BOTTLE WITH RIPCAP, AND 250 ML BOTTLE WITH SCREW CAP
its initial launch, so it has built a relatively strong presence
in metropolitan bars, western-style restaurants, but also in
‘‘Izakaya’’ chains (casual Japanese pubs). After this, TWO
DOGS distribution was expanded into the off-premise with
a key focus being convenience stores, such as 7–11 and Family-
mart, as this is where the majority of the young adults targeted
by TWO DOGS tend to shop, perhaps on their way out to a
party or while coming home from work. TWO DOGS is also
sold in supermarkets, where it is available mainly for those
who enjoy consuming the product at home. With its relative
premium price, discount stores are not a targeted channel for
TWO DOGS.
Price
Retail prices for most consumer goods are relatively high in
Japan; therefore it is expected that TWO DOGS is relatively
more expensive than in its home country. In Australia one 330
ml bottle of TWO DOGS can be purchased at about A$2.00
dollars in the off-premise and A$5.00 in the on-premise, while
in Japan the 250 ml bottle is priced (in Yen) equivalent to
A$3.50 in the off-premise and up to A$9.00 in bars. The key
pricing issue for TWO DOGS in Japan is its premium price
against most of its competitors. Locally made ‘‘chu-hi’’ drinks
are priced at Yen 130 while TWO DOGS is around Yen
220 per bottle—a 70 percent premium. This pricing is in line
with the premium positioning of the brand and is influenced
by several factors:
• Support to position its brand as premium brand.
• Heavy spending on advertisement and promotion
• Cost of adaptation of products on bottle size and cap
• Cost of importing the product.
 Case 23 • Two Dogs Bites into the World Market: Focus on Japan
Advertising and Promotion
TWO DOGS advertising campaign is different in Japan.
An obvious distinction is the portrayal of the two dogs. In
Australia and for other selected international markets such
as the U.S. and Germany, the bulldogs are featured as tough
party animals (refer Exhibit 7), while in Japan, the bulldogs
are cute lovable characters (Exhibit 8). The Exhibits show the
comparison between TWO DOGS posters in Australia and
that of Japan.
EXHIBIT 7
TWO DOGS’ POSTER IN AUSTRALIA
EXHIBIT 8
TWO DOGS’ POSTERS IN JAPAN
• 753
THE FUTURE
Undoubtedly TWO DOGS entry into the Japanese market
has been successful due to the rigorous market research con-
ducted, the strength of its distribution partner, and its ability to
adapt the marketing mix to suit local conditions. The ongoing
challenge for management is to maintain and grow its market
share in a highly competitive environment, while selling at a
premium price in unfavorable macroeconomic conditions that
are unlikely to improve in the short term.
754 • Case 24 • ABC Chemical Company Goes Global
The ongoing economic recession in Japan will continue
to erode consumer purchasing power and confidence; luxury
goods will suffer as consumers move toward cheaper products.
This is already becoming evident: consumption of cognac and
premium whisky is declining in Japan. Since TWO DOGS
was launched in 1998, there has been massive growth in the
sales volume of cheaper products, such as ‘‘Can Chu-Hi’’ and
‘‘Hyoketsu Chu-Hi’’. These locally made Japanese brands are,
in convenience stores, almost half the price of fully imported
TWO DOGS.
DISCUSSION QUESTIONS
1. Should TWO DOGS maintain its premium price and thus
risk losing volume growth to cheaper products during the
recession?
䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬
C ASE 24
ABC CHEMICAL COMPANY GOES GLOBAL
Driven by competitive pressures, and the attractiveness of the
industry’s fastest growing market in the world, a U.S.-based
chemical manufacturer, ABC Chemical Company (name
changed to maintain confidentiality) considered expansion
into Asia, specifically, China.
William Smith is the International Marketing manager
for ABC Chemical Company. William has been tasked with
expanding ABC’s manufacturing and distribution to the Asia
Pacific region. Many changes in the powder coating industry
have forced ABC to reconsider their global strategy. To date,
they have exclusively manufactured and exported from the
Americas. Higher costs and tougher competition have forced
ABC to look to the Asia Pacific region to reduce these costs
(specifically shipping) and remain competitive.
ABC Chemical Company is a U.S.-based business that
manufactures and distributes specialty chemicals to various
industries for use in manufacturing finished products. ABC
Chemical Company’s powder coating division needs to expand
into Asia to remain competitive. Many of the powder coating
division’s customers are moving their plants to Asia in an
attempt to expand their markets and lower their production
costs. As well, all of ABC Chemical Company’s competitors
are opening production facilities in Asia to meet their cus-
tomer’s needs, to expand their markets, and lower their costs.
For Asian and some European manufacturers, powder coat-
ings are a commodity with no specific qualities or competitive
advantages to differentiate one from another. ABC Chemical
Company believes that in the future, many of these manu-
facturers will need more specialized products moving away
from a commodity. Gaining a foothold in Asia at this time is
This case was prepared by Kevin Hendrickson, Roberto Mandanici, and
Scott Solomon of the Fox School of Business and Management at Temple
University under the supervision of Professor Masaaki Kotabe for class dis-
cussion rather than to illustrate either effective or ineffective management
of a situation described (2003).
2. What effect would lowering its price have on its brand
positioning?
3. Would lowering its price require TWO DOGS to change
to a licensing strategy? If so, should local production be in
Japan? Or in nearby Asian countries with lower manufac-
turing costs, such as China or Thailand?
4. What other options does TWO DOGS have? Could the
company change to a multi-brand strategy by introducing a
new brand targeting the low-end segment?
critical to ABC Chemical Company’s future. As a commodity,
powder coatings are purchased strictly based on price. Ship-
ping costs to Asia have raised prices to a point where ABC
Chemical Company would either lose money if they met their
competitor’s price or lose customers if they did not. As an
example it costs ABC Chemical Company $1.50 per pound to
manufacture in the U.S. and ship to Asia and only $0.50 per
pound to manufacture in Asia.
Following the lead of many of their competitors, ABC has
chosen to manufacture in China. Entering China has many
benefits including a large relatively untapped market, lower
overall costs, lower restrictions on production, and a central
proximity to the rest of Asia. Many of ABC Chemical Com-
pany’s direct customers are either moving to or are already
located in China. As well, China and Asia are underserved
markets for ABC Chemical Company and many of their com-
petitors. Moving to China is necessary to maintain market
share as well as seek incremental business from new markets.
One of ABC Chemical Company’s goals is to become a global
supplier of specialty powder coatings. To achieve this goal,
they must expand into Asia through China.
ABC Chemical Company has chosen to build its own
plant in China rather than to form a partnership or acquire
an existing company. When seeking partners, ABC Chem-
ical Company encountered a number of issues surrounding
business practices in China. These business practices violated
ABC Chemical Company’s code of conduct and ethical objec-
tives. Although these specific business practices are common
in China and have been accepted and adopted by competi-
tors, ABC Chemical Company has chosen not to follow suit.
Instead, ABC Chemical Company has chosen to build their
own facility. While building has a number of advantages, there
are a number of disadvantages to consider as well. Advantages
include:
• Full control of the facility
• Building to exacting standards rather than adapting an
existing facility

• Maintaining quality standards similar to other ABC Chem-
ical Company plants
• Maintaining company code of conduct and ethical standards
Disadvantages include:
• One to two years to build a facility, slowing speed to market
(competitors already producing, including North American
and European manufacturers who have partnered with local
firms as well as thousands of small local competitors)
• Exporting from U.S. facilities at a loss
• Lack of local partners and knowledge may impede entry
into market
While ABC Chemical Company builds their factory in
China they will continue to supply Asian customers from their
North American manufacturing facilities, at a substantial loss
due to logistical and transportation costs.
COMPANY OVERVIEW
ABC Chemical Company is one of the world’s largest man-
ufacturers of specialty chemicals—technologically sophisti-
cated materials that find their way into applications in a
variety of major markets. Consumers never see most of
ABC’s products; rather, they are used by other industries
to produce better-performing, high-quality end products and
finished goods. The history of ABC Chemical Company has
been a series of innovative technical contributions to science
and industry, usually taking place behind the scenes.
Markets where extensive use is made of ABC’s products
include the paint and coatings industry, electronics, household
products/detergents/personal care, water treatment, adhe-
sives, plastics, and salt. In every corner of the world, ABC
products are Quietly Improving the Quality of Life.
In the late 1990s, ABC acquired two great compa-
nies—Ronlea (name changed), a maker of electronic chem-
icals, and Tomro International (name changed), a global
producer of specialty chemicals and salt.
ABC has sales of approximately $6 billion and more than
17,000 employees. It operates nearly 140 research and man-
ufacturing locations in 27 countries. The company has more
than one hundred ISO 9000 and more than twenty-five ISO
14000 EMAS registrations around the world. Worldwide head-
quarters are located in the United States. ABC is a Delaware
corporation whose stock is traded on the New York Stock
Exchange under the symbol ABC.
ABC is committed to being a good neighbor and responsi-
ble corporate citizen. At various places on their web site there
are discussions of a number of initiatives, including Responsi-
ble Care, Community Advisory Committees, and activities
centered on the health and safety of employees, customers, the
communities where they are located, and the environment.
ABC CHEMICAL COMPANY’S CODE OF CONDUCT
ABC Company stresses the importance of its code of conduct
to each employee worldwide. The code is strictly embraced
and enforced at all levels of the organization: from the CEO
and the Board of Directors to each entry-level salaried staff
position. In fact, once a year each salaried employee is asked
to: 1) sign the Code of Conduct and certify that he/she has not
violated any of the ethical provisions contained in it; and 2)
Case 24 • ABC Chemical Company Goes Global • 755
certify that he/she is not aware that any other employee has
violated the code.
Portions of the Purchasing section of the code of conduct
are reported below:
Relationships between ABC Company and its suppliers
should be based on mutual respect and integrity. These rela-
tionships should be maintained at the highest standards of
business ethics. [. . .] Under no circumstance may an ABC
employee misrepresent a competitive situation to a supplier.
ABC Company does not require nor does it expect any form
of entertainment, promotional gifts or holiday cards as a con-
dition for doing business. It is strictly prohibited for an ABC
purchasing agent to solicit any gifts or entertainment or accept
spontaneous nominal gifts valued in excess of $50; accepting
any cash gift; traveling at a supplier’s expense or participating
in a supplier-sponsored training seminar that is extravagant in
nature. [. . .] Any supplier or employee who suspects that an
ABC employee is not operating within the Code of Conduct,
should promptly report their suspicion anonymously to the
ABC Compliance Hotline at 1-800-123-4567.
The General Code of Business Conduct repeats, in part,
the provisions mentioned in the Purchasing Code, and adds
the following:
Gifts of cash or property may not be offered or made to
any officer or employee of a customer or supplier or any gov-
ernment official or employee unless the gift is legal, nominal in
value (less than $50) and approved in advance by a Director or
Business Executive (in most countries it is illegal to make gifts
to government officials).
Conflicts of interest: any employee who has a financial inter-
est or performs work for a company with which we do business
or compete, must disclose such conflict to the respective Director
or Business Executive.
Securities Transactions: at times, some ABC employees
may become aware of confidential information that has not yet
been disclosed to the general public. In those cases, the infor-
mation must be held in strict confidence. Those who became
aware of such information may not buy or sell company stock,
nor advise others to do so, until the information has been made
available to the general public.
Safety, Health and Environmental laws: ABC conducts its
worldwide operations and manufactures its products in a way
as to not harm the environment and the health and safety of its
employees, customers and the public. ABC is also committed
to complying with all local applicable laws and regulations.
Accounting records: ABC’s financial statements and the
books of record on which they are based must accurately reflect
all corporate transactions. All receipts and disbursements must
be accurately reflected on the accounting books, and ABC’s
records must disclose the nature and purpose of all corporate
transactions. [. . .] ABC employees are instructed to cooperate
fully with both internal as well as external auditors and withhold
no information from them.
Other accounting and internal control provisions pertinent
to the case study are as follows:
1. Bank accounts: the corporate treasurer must approve the
establishment of all bank accounts.
2. Financial arrangements: the corporate treasurer must
approve all financial arrangements with banks such as:
756 • Case 24 • ABC Chemical Company Goes Global

loans, sales or purchases of securities; dealing in foreign
currency; etc.
3. Cash disbursements: every disbursement (with the excep-
tion of petty cash) must be supported by an approved
Purchase Order or Check Request. The full name of the
payee must be recorded on the payment. Checks may not
be made payable to ‘‘cash’’, ‘‘bearer’’ nor the individual
approving the transaction.
4. Employee compensation: all payments to employees must
be justified based on services rendered. Employees may
not be asked to refund a portion of their compensation or
spend it in an illegal or unethical manner.
5. Billing: all shipments must be billed promptly and accu-
rately.
6. Cash receipts: all checks made payable to the Company
must be deposited in an ABC checking account promptly.
Checks received from customers may not be endorsed
to a third party as a means of payment for our pur-
chases.
7. Sales agents and commissions: only respected and compe-
tent agents or distributors may be hired to represent ABC
Company. All commission payments must be properly
recorded on the accounting books with full documentation
including the name of the payee, the commission rate, the
product sold and the customer orders involved. Cash pay-
ments, payments to unnamed individuals or disguised bank
accounts are not permitted.
8. Consultants: all engagements with consultants and advisors
must be based on ABC’s needs for technical or profes-
sional assistance. The background and professional ability
must be scrutinized carefully before engaging a new con-
sultant. All invoices received and paid must accurately
describe the services rendered and the basis for the fees
charged.
9. Unusual business transactions: all transactions outside the
normal course of ABC’s business (sale of scrap material,
leasing of buildings and equipment, entering into a new
business activity, etc.) must be authorized by a Business
Unit Manager or a Vice-President.
10. Accounting records: all corporate transactions must be
reflected in the accounting records. Any fictitious or unau-
thorized entries are strictly forbidden.
INDUSTRY OVERVIEW
Powder Coatings (dry paint), a relatively new technology,
is an economical and environmental improvement over the
traditional liquid paint. It is mostly used by Original Equip-
ment Manufacturers (OEMs) and by small custom ‘‘job-
shops.’’
The application characteristics of powder coatings provide
superior consistency and uniformity of finish. They provide
extremely tough, durable coats, enhancing the high-quality,
value-added image of consumer products. In general, per-
formance properties such as impact resistance and corrosion
resistance of powder coatings are better than liquid paints.
Powder-coated parts resist cracking and peeling during han-
dling and normal service use. In many cases, merchandise is
specifically being advertised as ‘‘powder coated’’ because of
the quality image it projects.
‘‘Environmental issues are of significant interest and impor-
tance to the government and general public today. Unlike
many liquid paints, powder coatings are compliant with envi-
ronmental regulations. Liquid paints often contain solvents,
which can contribute to air pollution and, in some cases, ozone
depletion. Powder coatings are free of such pollutants. Wet
painting processes can generate sludge, which must be dis-
posed of into hazardous waste landfills. Properly formulated
powder coatings generate no such hazardous waste. The con-
sumer can feel good about buying a powder-coated product,
which is environmentally responsible.’’1
The global powder coatings market registered an estimated
$3.5 billion in sales in the year 2002. The three major markets
are Europe (with sales of $1.3 billion), North America (with
sales of $1 billion), and Asia Pacific (with sales of $0.85 billion)
(see Exhibit 1).
The global powder market is dominated by three major
players (see Exhibit 2):
1 Source: ABC’s website.

EXHIBIT 1
GLOBAL POWDER COATINGS MARKET

$200 $150
North America
$1,000 AGR 6-7%
Europe
AGR 3-4%
$850 Asia Pacific
AGR 12-15%
Latin America
AGR 10-12%
Rest of World
AGR 10-12%

Values are 2001 estimates in Millions of

$1,300 US$ and Estimated Annual Growth
Rate (AGR) for the next 5 years
 Case 24 • ABC Chemical Company Goes Global
EXHIBIT 2
GLOBAL POWDER MARKET POSITIONS
ABC Company
6%
1,000 Others Wooden Shoes
44% 13%
Delco
11%
F
5%
P
4%
G J
H B 3%
2% T V 3%
3% 3% 3%
1. Wooden Shoes, a Dutch company, is the market leader
commanding 13 percent of the worldwide market. Wooden
Shoes is the leader in Europe and in Asia Pacific.
2. Delco, a U.S.-based corporation, owns 11 percent of the
global market, with a second-place position in all three
major markets, including Asia.
3. ABC holds a 6 percent global share, with a narrow number
one position in the U.S., and the second position in Europe.
ABC’s presence in Asia is negligible at 0.2 percent.
4. Eight other smaller producers own 26 percent of the mar-
ket. These powder coatings manufacturers operate in select
regional markets, concentrating their efforts on single-type
customers and speed of delivery.
5. The remaining 44 percent of the market is composed of
over 1,000 single-plant producers who serve a handful of
local customers and specialize in a narrow line of products.
They compete on speed and price, since their low-tech
and high-volume production of similar products allows for
economies of scale.
Although Europe is the largest market, it represents a
mature industry where margins are low and the powder coating
product is considered a semi-commodity. Estimated growth
rates for the next five years are approximately 3–4 percent
per year, while customers are not willing to pay higher prices
for improved technology. In fact, technological improvements
are a means to retaining business rather than increasing prices
and margins. ABC holds the number two position in Europe
(behind Wooden Shoes) using low-cost, consistency, an estab-
lished network of agents and distributors, as well as speedy
delivery as its differential advantage.
The North American market is a younger market, and
benefits from larger margins, with estimated growth rates of
6–7 percent over the next five years. North American OEMs
require a higher degree of technological innovations from
their powder coatings suppliers, and thus are willing to pay a
• 757
higher price per pound. ABC Chemical Company is the mar-
ket leader in North America, specializing in highly customized
and specialty powders. ABC’s strengths are:
• Color-matching abilities
• Speed of delivery
• Innovation
• Low-temperature curing powders, which lead to energy
savings
• Powders that can be applied with a thinner film, thus being
able to cover more surface per pound
• A highly skilled sales force
Asia Pacific is the smallest of the three major markets (with
$0.85 billion sales) but offers a very attractive growth rate of
12–15 percent per year. Although this is the youngest market,
it already shows signs of price and margins erosion. Customers
consider powder coatings as a simple means for painting parts,
and place little to no value on technological differentiation.
The environmental benefits of powder coatings are also of
little importance to the Asian market (due to less stringent
environmental regulations).
The Asian powder coatings manufacturers’ arena is dom-
inated by over 1,000 small entrepreneurial businesses rep-
resenting 78 percent of the market share (see Exhibit 3).
Wooden Shoes and Delco control 9 percent and 4 percent of
the market. Powder coatings are used mainly to cover small
parts for export to the industrialized countries. Many Ameri-
can manufacturers that are moving their operations to Asia in
order to capitalize on lower labor and raw material costs fuel
the high degree of growth. ABC’s vision is that these manufac-
turers will require the same degree of service and technology
that was demanded in their North American facilities, thus
providing for higher margin sales in the future.
While ABC decides on the course of action, it will supply
powder coatings to the Asian market from its North American
manufacturing facilities. Although this is a strategic choice to
758 • Case 24 • ABC Chemical Company Goes Global
establish a presence in the new market, ABC faces losses due
to shipping charges and tariffs, as well as having to lower
price in order to compete against local Asian manufacturers
capable of producing at a fraction of ABC’s costs.
EXHIBIT 3
ASIA PACIFIC MARKET POSITIONS
ABC Wooden Shoes Delco
0% 9% 4%
F had its strengths; Guangzhou benefited from its proximity to
3%
N
3%
D
3%
1,000+ Others
78%
CHINA—SHANGHAI REGION
The rationale to locate in Asia was driven by several factors,
most notably the increasing size and importance of the powder
coatings market in the Pacific region and the ability to enjoy
lower labor costs. Additionally, the logistics of shipping U.S.-
produced powder coatings to Asia made selling to the Asian
market in a profitable manner impossible. Since this region
is home to much manufacturing as well as several developed
and emerging markets, ABC needed to have a production
facility in Asia in order to serve that region. In fact, its major
competitors are already operating there!
When choosing which country in Asia from which to oper-
ate, the answer quickly became obvious: China. China is
home to the lion’s share of the manufacturing facilities that
require powder coatings. Traits common to China that are not
all present in most other Asian countries being considered
EXHIBIT 4
CHINA AND NEIGHBORING REGIONS
are access to cheap raw materials (petroleum-based resins),
lower environmental regulations, competitors and customers
are already there, and the access to cheap unskilled and
semi-skilled labor. All of these factors would allow ABC to
maximize its profit potential.
ABC Chemical Company had been considering several
sites in China, all along its populated and developed east-
ern shore (see Exhibit 4). Markets that met the final cut
included Guangzhou, Shanghai, and Fuzhou. Each market
Hong Kong, which led to capitalistic laden tendencies in this
part of China that might help ABCs business operations from
a functional standpoint. The port provided access to major
shipping routes to the rest of the world, which was attractive
to ABC’s customers. Fuzhou had similar attributes and was
close to Taiwan as well. Shanghai was a major port city and in
the areas surrounding it, much manufacturing capability was
present and much new construction was taking place.
In the end, ABC chose to locate in the Shanghai region of
China. While each market would serve ABC’s needs, manage-
ment felt that Shanghai made the most sense based on their
current needs and future expectations. Management guessed
that many potential future customers would likely choose to
enter China or expand their presence in China via a Shanghai
area production facility. Thus, ABC would be close to many
of its customers and be able to ship to them quickly at a low
cost. Furthermore, the infrastructure between cities in China
is quite poor. Shanghai is centrally located along the coast and
thus if land-based transportation options broke down, ABC
could utilize ocean-based shipping options to serve China.
Another important benefit was that Shanghai provided good
geographic proximity to most other Asian manufacturing and
consumer markets in Japan, Korea, and Taiwan.
BUSINESS PRACTICES IN CHINA
Ideologically, China is a socialist country, but in an economic
sense, the country is displaying some capitalistic tendencies.
The country has been willing to embrace some concept of a
free market in order to foster economic growth. Examples of

this relaxing of ideology may be seen simply in the fact that
foreign multinational corporations (MNCs) are operating in
the country.
Despite the fact that China has opened somewhat, there
are still systems (both stated and implied) in place, which
restrict freedom for economic growth. In the more official
sense, China’s equity markets are closed to private startups
and there is widespread piracy, restricting economic growth.
As well, the government maintains price controls in over
twenty industries, censures the press, and does not allow full
Internet access. Unofficial systems in place in the country,
which tend to impede efficient markets, are the nuances of
getting things done, namely bribery and facilitating payments.
In China, there are many rules, but not necessarily laws.
The rules are subject to change at anytime by anyone, pro-
vided you have the right access to government officials willing
to alter their views. Additionally, there are multiple govern-
ment agencies/ministries with overlapping jurisdictions. The
main government body is known as the State Council, which is
the highest administrative body in the country. Other govern-
ment agencies that have an effect on commerce, particularly
international trade, include the Ministry of Foreign Trade and
Economic Cooperation (MOFTEC), State Administration for
Industry and Commerce (SAIC) and the State Bureau of
International Trade (SBIT).
POLITICAL RISK IN CHINA
Countries that lack political stability or are inconsistent in the
application of laws create a reputation among international
firms that they are more risky. While China has made great
efforts to open its doors to international business, the country
is still considered very risky. This is because China does not
have an effective legal system, or reliable commercial code
establishing rules of commercial interactions and obligations.
This is due to the fact that situations often fall under the juris-
diction of multiple government bodies, which often contradict
one another. These elements make firms less willing to invest
large amounts of money. While the amount of foreign invest-
ment in China is large, metaphorically speaking, it amounts
to no more than a toe in the water with respect to the value
these firms would be willing to invest if the government were
run differently.
CODE OF CONDUCT IN CHINA
Many nations have enacted legislation attempting to control
the behavior of domestically based firms in their operations
abroad. Such laws are meant to limit corrupt or immoral
behavior in dealing with other countries. The laws were
particularly expected to apply to dealings with second and
third world countries. The most relevant international accords
relating to this fact are
• The United Nations Universal Declaration of Human
Rights—1948
• The European Convention on Human Rights—1950
• The Helsinki Final Act—1975
• OECD Guidelines for Multinational Enterprises—1976
• The International Labor Office Tripartite Declaration of
Principles Concerning Multinational Enterprises and Social
Policy—1977
Case 24 • ABC Chemical Company Goes Global • 759
• The United Nations Code of Conduct on Transnational
Corporations
Over time, these accords have set up a series of explicit guide-
lines for the behavior of international companies in countries
in which they operate; outlining codes of conduct, basic obli-
gations, and upholding policies benefiting basic human rights.
The broad categories regulated are employment practices,
consumer protection, environmental protection, political pay-
ments, and basic human rights.
The political payments section is most germane to ABC’s
entry into China. The various accords noted above speaking
on this topic say the following:
• MNCs cannot pay bribes or make improper payments to
public officials
• MNCs should avoid improper or illegal involvement or
interference in the internal politics of host countries
• MNCs should not interfere in intergovernmental relations.
While these guidelines were expected to limit corruption,
bribery remains pervasive. The United States went a step fur-
ther than the U.N. dictates and passed the Foreign Corrupt
Practices Act (FCPA) in 1977. The law specifically allows
facilitation payments, but does not permit bribery. This law
makes it illegal for a U.S. citizen to make a corrupt payment
to a member of a government for the express purpose of
having that office grant a contract or other business back to
the firm. The law also includes making payments to interme-
diaries (who would in turn make bribes on the firm’s behalf).
Penalties for individuals found guilty of the FCPA law include
five years imprisonment and a fine of $100,000. Firms can be
fined up to $2 million. Because bribery is often necessary to
make things work in China, many U.S.-based firms could not
legally do business there.
POTENTIAL TARGET COMPANIES EVALUATED
In order to evaluate potential Chinese firms that ABC may
partner with, ABC hired the Shanghai office of PriceWa-
terHouseCoopers (PWC). PWC was hired to analyze the
accounting and business practices of a number of companies.
Two companies, Target #1 and Target #2 (names changed
to protect confidentiality) rose to the top and a synopsis of
PWC’s report follows.
PWC reported that part of Target #1’s financial infor-
mation was not reported to government authorities and tax
liabilities were under-recorded and underpaid. In fact, Target
#1 keeps two sets of financial statements. One set of financial
statements is audited and used for external reporting purposes
such as the basis for tax assessments. The second set is used
for management reporting and includes revenue and assets
not reported on the external statements. To understand the
magnitude of this phenomenon, PWC provided documenta-
tion showing that in the year 2000 Target #1 reported only
33 percent of sales and 12 percent of revenue on the external
statements.
PWC advised that since a significant portion of the com-
pany’s revenue and expenses was not reported to government
authorities, significant tax liabilities [Value Added Tax (VAT)
and income tax] are underrecorded and underpaid. In addi-
tion, penalties arising from these unreported tax liabilities
760 • Case 24 • ABC Chemical Company Goes Global
may be incurred as the above activities violated the People’s
Republic of China (PRC) accounting and tax laws.
Local management further advised the PWC partner that
over 60 percent of Target # 1’s sales were made to Taiwanese
companies. Most of this revenue was not reported to PRC
government authorities as sales invoices were not issued. As
a common business practice in the Shanghai region, Target #1
has agreements with these customers under which the sales
revenue will be collected by Target #1’s parent company in
Taiwan in foreign currencies (Taiwan New Dollars or Hong
Kong Dollars) from the customers’ parent companies in Tai-
wan. When Target #1 needs cash, management will bring
foreign currencies from its parent company to China without
declaring it to customs. Consequently, these foreign currencies
will be exchanged into Yuan Renminbi (Chinese Currency,
Rmb) in the black market. As these transactions violated the
PRC foreign currency administration regulations, significant
contingent liabilities exist.
Another major issue is the treatment of the VAT. As
required by certain customers, VAT invoices were not issued
so that those customers can report less revenue and VAT
liabilities to government authorities.
Management advised that it is a common business practice
in Shanghai that suppliers are requested not to issue sales
(VAT) invoices to customers. In 2000, 67 percent of Target #
1’s sales did not have VAT invoices. This enables customers
to exclude these purchases from their official accounting
records and consequently exclude sales revenue from the
official accounting records and report less tax liabilities to
government authorities.
As this practice is not consistent with ABC’s Code of Busi-
ness Conduct, the risk of losing customers and sales revenue
exist should ABC Chemical Company take over Target #1’s
business and insist on issuing VAT invoices to customers. As
a consequence, the following may occur:
1. Customers may terminate business with ABC Chemical
Company as VAT invoices are audit trails that may raise
the suspicion of the tax authorities and lead to the eventual
discovery of the previous improper practices.
2. Customers may be unwilling to pay VAT for purchases
from ABC Chemical Company as they do not need input
VAT to offset their VAT liabilities. Accordingly, ABC may
have to absorb the VAT as part of the cost of sales. This
will lower ABC Chemical Company’s gross margin. (For
example, if Target # 1 had to absorb VAT for customers in
2000, its gross margin would be lowered from 17 percent to
6 percent).
Furthermore, during a plant visit, PWC noticed returned
and obsolete inventories. However, no provision for inventory
obsolescence was made. Management estimated the costs of
these obsolete or returned inventories to be Rmb 640,000.
These inventories either had quality problems or did not have
market demands. As these inventories will be of little value
to ABC, ABC may wish to consider excluding these aged
inventories from the proposed acquisition. Local manage-
ment acknowledged that Target #1 has been utilizing obsolete
inventories in production and this could cause quality prob-
lems. Accordingly, sales returns and quality disputes may
occur in the future. In 2000, sales returns accounted for 2.5
percent of total sales.
PWC partners also found that Target #1’s management
has also been understating the reserves for doubtful accounts,
and overstating assets. Both accounting practices should be
carefully examined by ABC company, as they have the effect
of inflating the market value of the Target company. Addi-
tionally, in 1997, Target #1 purchased certain equipment and
machinery from its investor in Taiwan. These assets were
exempt from VAT or custom duties according to PRC tax
regulations. However, the exempted VAT and custom duties
would become payable if these assets are sold within the next
6 years.
Other matters of concern are the following:
1. Target #1 provides kickbacks to customers to boost sales.
Although management indicated that kickback payments
to customers were not a key incentive to promote sales, as
most of the customers are private companies, the amounts
recorded over the previous two years would be considered
material by government officials.
2. Over 60 percent of sales are made to Taiwanese compa-
nies. Management stated that Taiwanese firms prefer to do
business with other Taiwanese firms due to cultural reasons
and flexible payment arrangements and acknowledged that
it was very difficult for non-Taiwanese companies to sell
products to Taiwanese customers. Accordingly, the risk of
losing Taiwanese customers may exist if ABC Chemical
Company acquires Target #1.
3. A proper accounting system has not yet been established
in Target #1. Some accounts do not have accounting
ledgers and financial statements are prepared manually
from vouchers at period end. Additional investments to
improve working efficiency will be required if ABC Chem-
ical Company acquires Target #1.
PriceWaterHouseCoopers was also involved in analyzing
the business practices of a second Chinese-based company
named Target #2 (name changed to maintain confidentiality).
Many of the issues found at Target #2 were similar to those
affecting Target #1.
Target #2 also keeps two sets of financial statements; one
for external and tax purposes, and one for management.
Furthermore, as seen with the first target company, this enter-
prise does not issue VAT invoices in their entirety. In fact
only 20 percent of sales are invoiced. However, in early 2001,
Target #2 issued more sales invoices and only 37 percent of
its sales did not have VAT invoices. Management advised
that the reason for issuing more invoices and paying more
VAT was to make local tax authorities believe that it was a
good taxpayer so as to avoid a comprehensive tax audit. This
approach also led Target #2 to request its suppliers to invoice
a higher percentage of their purchases in order to offset the
VAT charged to its customers. This created some tension with
Target # 2’s supplier base.
As stated above, if ABC Company takes over the opera-
tions of Target #2 and insists on issuing VAT invoices in their
entirety, customers may terminate their business relationship
since VAT invoices are audit trails that may raise the suspicion
of the tax authorities and lead to the eventual discovery of
the previous improper practices. Another option would be for
ABC Chemical Company to absorb VAT into their cost of
sales, thus lowering the overall profitability of the operations.
 Case 25 • DaimlerChrysler for East Asia • 761

As with Target #1, obsolete inventories and inadequate DISCUSSION QUESTIONS

accounting systems were observed during the analysis of Tar-
get #2. Kickbacks, although in lower amounts, are also paid
1. Should ABC enter the Asian market?
to employees of their customers as a way to attract and retain
business. 2. Because of the Code of Conduct that ABC adheres to,
there were no appropriate joint venture candidates with
WILLIAM’S DILEMMA which to partner. Why not operate in Taiwan or Korea and
As William’s plane flies over the Bering Sea after two weeks in then export to China?
China, he reviews the independent auditor’s report on ABC’s 3. Is there anything that ABC can do to enter China with a
two target companies. His meeting with the CEO is only joint venture partner and still operate within its Code of
12 hours away and he is concerned about his presentation. Conduct?
William’s dilemma is that ABC must either enter at the sacri-
fice of their company code of conduct or delay entry by two
years and lose money on current customers in that time.

䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬 䉬

C ASE 25

DAIMLERCHRYSLER FOR EAST ASIA

INTRODUCTION merged after a shareholders’ meeting in November to form
DaimlerChrysler, the third largest automobile manufacturer
On May 6, 1998 the management board of Daimler Benz
in revenue after GM and Ford Motors, and the fifth largest
approved the $130 billion merger that created Daimler-
in market share (see Exhibit 1). It was the largest industrial
Chrysler. The merger leapfrogged DaimlerChrysler into the
merger ever. The merger was clearly driven by the industrial
big league of global automobile manufacturers combining
logic and growth strategy to win in the global automotive
Daimler-Benz’s solid engineering and production techniques
market.
centered around one of the world’s greatest luxury brands
with Chrysler’s famed resilience and creative design strength,
especially in the light trucks, minivans, and sport utility vehi- EXHIBIT 1
cles (SUVs). The combined firm ranked fifth in worldwide 1997 World
automobile production. Rank/Company Market Share
At some point during his attempt to successfully integrate
DaimlerChrysler, Jurgen Schrempp, the CEO of Daimler- 1 General Motors 16.2%
Chrysler, must have realized that there were two large gaps in 2 Ford Motor Co. 12.9%
his strategy to create a truly global automotive manufacturer. 3 Toyota Motor Corp. 9.0%
The most obvious was the total lack of a significant presence 4 Volkswagen AG 7.9%
in East Asia. The other gap was a standard vehicle to sell in 5 DaimlerChrysler 7.4%
East Asia and other growing markets. In the aftermath of the 6 Fiat Auto S.p.A. 5.3%
Asian financial crisis, Schrempp must have sensed both the
7 Nissan Motor Co. 5.2%
opportunity and the threat that the situation presented: the
8 PSA Peugeot Citroen 3.9%
opportunity to enter markets where cultures, legal restrictions,
and ingrained competitors suddenly became loosened in wake 9 Honda Motor Co. 3.8%
of the crisis, and the threat of other strong competitors staking 10 Mitsubishi Motors Corp. 3.5%
out a share of the same market with more marketable products
before DaimlerChrysler could react. With the seismic shifts
Several industry trends propelled the large automobile
occurring in the industry, Schrempp wondered what sort of
makers towards consolidation. First, the worldwide market
strategy to pursue. Whatever strategy DaimlerChrysler chose
for automobiles was maturing. Total automobile produc-
would have to take into consideration the ongoing worldwide
tion in the world was 54.7 million in 1997, 52.9 million in
consolidation, and existing industry relationships in East Asia.
1998, and 55.9 million in 1999 (see Exhibit 2). There was
CONSOLIDATION IN THE WORLDWIDE AUTOMO- only a 2 percent increase in two years, although the growth
BILE INDUSTRY potential was higher in the markets of developing countries
Daimler-Benz in Germany and Chrysler in the United States such as Asian and Latin American countries. In a maturing
made an announcement to merge on May 10, 1998. They market, competition among established companies tends to
intensify because someone’s gain in share means someone’s
This case was prepared by Takashi Morishima, Gordon Stehr, and loss in numbers. Second, all markets but the United States
Hanaoka Yoshinori of Temple University in Tokyo under the supervision
had far more production capabilities than required to satisfy
of Professor Masaaki Kotabe for class discussion rather than to illustrate
either effective or ineffective management of a situation described (2001). domestic demand. According to 1999 statistics, every major
762 • Case 25 • DaimlerChrysler for East Asia

automobile manufacturing country except the United States automobile manufacturers to start engaging in a wide range
exported more than 40 percent of its domestic production of strategic alliances and other consolidation tactics.
(see Exhibit 3). Also it is a known fact that Japan and South Chrysler was basically a North American company. It was
Korea had overcapacities in automobile production because strong in lower and medium priced cars, and very strong in
of Japan’s long recession and the Asian financial crisis in 1997. small trucks, minivans, and sport utility vehicles, but weak
In a combination of maturing markets and overcapacity it internationally. Daimler’s Mercedes Benz was strong in the
would be very difficult for any company to grow by oneself. upper part of the automotive market in Europe, but not in
the U.S. Also, Daimler was considered to have an advantage
EXHIBIT 2 in environmental technology, which Chrysler lacks. Together,
AUTOMOBILE PRODUCTION they became a full-range auto company, capable of compet-
(UNITS BY THOUSAND) ing in almost every area, equipped with huge cash flow and
technology around the world.
1997 1998 1999
EXHIBIT 3
North America 14,694 14,572 16,066
EXPORT/DOMESTIC SALES RATIO
South America 3,870 3,503 3,186
IN 1999
Western Europe 15,453 16,782 16,939
Eastern Europe 2,468 2,400 2,453 Export Domestic Sales
Asia 17,516 15,014 16,343
Spain 81.1 18.9
World total 54,695 52,922 55,629
Sweden 80.1 19.9
France 67.8 32.2
Third, costs for developing new cars are mounting. Envi- Germany 64.6 35.4
ronmental technology such as an efficient engines, which cut UK 61.5 38.5
fuel consumption and CO2 emissions, and fuel cell technology, Korea 53.1 46.9
which eliminate CO2 emissions, is becoming a more pressing Italy 46.9 53.1
issue as people become more concerned about the environ- Japan 44.6 55.4
ment. Developing these new technologies is a huge investment US 9.6 90.4
for one company. Also, as the market matures, the demand for
passenger cars is becoming more and more diversified, and,
subsequently development costs for new models are rising as
GM AND FORD
automobile manufacturers try to accommodate the changes
in demand. Bigger companies can more easily bear these The two largest automobile producers, GM and Ford, also
costs, and it is easier to buy established names than to build had taken similar approaches as Chrysler, although in a
new plants in order to be bigger in maturing and overcapac- less significant fashion than DaimlerChrysler’s merger (see
ity markets. Considering these conditions, it was natural for Exhibit 4). In 1998, GM already owned a 100 percent equity

EXHIBIT 4
ACQUISITION ACTIVITIES IN GM AND FORD MOTOR
GM Name Nation Equity Stake

Before 1998 Opel AG Germany 100%

Isuzu Japan 49%
09/16/98 Suzuki Motor Japan 3.3% to 10%
12/10/99 Fuji Heavy Industry Japan 20%
01/31/00 Saab Automobile AB Sweden 50% to 100%
03/13/00 Fiat Italy 20%

Ford Name Nation Equity Stake

Before 1998 Mazda Japan 34%

Jaguar UK 100%
Aston Martin UK 100%
In 1999 Volvo Sweden 100%
In May 2000 Land Rover UK 100%
 Case 25 • DaimlerChrysler for East Asia • 763

stake in Opel, which produced about one-quarter of all Ger-
man vehicle output, and a 49 percent equity stake of Isuzu, the
ninth largest Japanese automobile manufacturer. Also, Ford
owned a 34 percent equity stake in Mazda, the fifth largest
Japanese automobile manufacturer, and 100 percent equity
stakes in Jaguar and Aston Martin, small but respected U.K.
automobile manufacturers.
After the merger of Daimler-Benz and Chrysler, GM
increased its holding in Suzuki Motors of Japan to 10 per-
cent in September 1998, and acquired a 20 percent equity
stake in Fuji Heavy Industries, makers of Subaru automo-
biles, of Japan, and acquired a 100 percent equity stake in
Saab of Sweden in January 2000. Ford also acquired Volvo’s
(Sweden) passenger car division in 1999. Furthermore, GM
announced its intentions to acquire a 20 percent equity stake
in Fiat, which is sixth in market share, on March 13, 2000.
However, after all this GM, the largest automobile man-
ufacturer in the world, still holds only a 4 percent market
share in the Asian Pacific region, but a 20 percent share of the
world market and 10 percent share of the European market
(see Exhibit 5). Automobile sales earnings of GM and Ford
in Asia are minus $218 million for GM and plus $133 million
for Ford, respectively (see Exhibit 6). These amounts are not
very exciting when compared with almost $6 billion income
for each company’s automobile sales.
DAIMLERCHRYSLER IN ASIAN PACIFIC REGION
DaimlerChrysler sold only 50,000 cars in Japan out of 4.9
million productions (see Exhibit 7). This is just 1 percent of
production and a 0.8 percent share of the Japanese mar-
ket although its Mercedes-Benz was the best-selling foreign
made car in Japan. Also the annual report listed no Asian
manufacturer or important subsidiaries in the area except one
company in India. In conclusion, while GM and Ford’s pres-
ence was weak DaimlerChrysler had no significant presence
in the Asian region in 1999.

EXHIBIT 5
VEHICLE UNIT DELIVERIES (UNITS IN THOUSAND)
North America 19968 36% 5706 28.6%

Total US 17419 32% 5017 28.8%

Others 2549 5% 689 27.0%
Europe 20138 37% 1979 9.8%
LAAME 3231 6% 536 16.6%
Asia and Pacific 11610 21% 457 3.9%
World total 54947 100% 8578 15.8

EXHIBIT 6
INCOME IN AUTOMOBILE MANUFACTURING IN FORD MOTOR CO. AND GM IN 1999
Ford Total North America Europe Latin America Others

Income($M) 5721 6137 28 −452 133

Revenue($B) 137 100 30 2 5

GM Total North America Europe LAAM Asia & Pacific

Income($M) 4981 4822 423 −81 −218

Revenue($B) 146 115 26.2 4.7 3.2

EXHIBIT 7
DAIMLERCHRYSLER UNIT SALES (UNITS IN THOUSAND)
M-B Passenger Chrysler Commercial Total

EU 716 267 983

NAFTA 212 3052 193 3457
US 197 2694 172 3063
Japan 50 50
South Africa 43 43
Rest 102 177 51 330

Total 1080 3227 555 4862

764 • Case 25 • DaimlerChrysler for East Asia

EXHIBIT 8
SUMMARY OF THE EAST ASIAN MARKET IN 1998
2) GDP per 3) Cars per 4) Domestic 5) Domestic 6) Export
Country 1) Population Capita 1000 people Sales Production Ratio

Japan 126.5 23,100 395 5,879 10,050 44.6%

Korea 46.4 12,600 227 780 1,954 69.7%
Taiwan 21.9 16,500 286 474 405 —
Thailand 61.2 6,100 100 144 158 32.1%
Indonesia 204.4 2,830 20 58 58 —
Malaysia 21.0 10,300 213 164 164 —
China 1,250.2 3,600 11 1,630 1,628 —

Notes Million US$ USA 484 Thousand cars

UK 461

EXHIBIT 9
PRODUCTION (THOUSAND CARS)
1997 1998 1999
Country Total Cars CVs Total Total

Japan 10,975 8,056 1,994 10,050 9,895

Korea 2,818 1,625 329 1,954 2,843
Taiwan 381 293 112 405 350
Thailand 360 32 126 158 327
Indonesia 389 8 7 134 205
Malaysia 266 126 7 134 205
China 1,580 507 1,121 1,628 1,830
India 746 384 244 628 803

Asia Total 17,516 11,031 3,983 15,014 16,344

EXHIBIT 10
JAPAN BY MAKE IN 1999 (NOTE: IMPORTS IN 1999 WERE 271,000.)
2) Domestic 3) D. Sales:
1) Domestic Production Market Export:
(Thousand cars) Share Overseas
Manufacturer Cars CVs Total for Cars Production

Daihatsu 479 183 662 8.2% —

Fuji 395 86 481 5.3% —
Hino 40 40 0.7% —
Honda 1,143 77 1,221 16.5% 1: 0.66: 1.76
Isuzu 38 223 261 1.8% —
Mazda 705 76 781 6.1% 1: 1.51: 0.47
Mitsubishi 753 261 1,014 7.8% 1: 0.73: 0.48
Nissan 1,210 175 1,385 13.7% 1: 0.79: 1.86
Nissan Diesel 23 23 0.2% —
Suzuki 679 230 909 9.9% —
Toyota 2,699 419 3,118 27.1% 1: 0.90: 0.97

Total 8,100 1,795 9,895 100%

 Case 25 • DaimlerChrysler for East Asia • 765

THE EAST ASIAN MARKET affected each company’s financial status. In addition, some
companies have not yet solved their domestic manufactur-
Production of motor vehicles in Asia reached 16,344,000 cars
ing overcapacity problems after shifting their manufacturing
in 1999, and accounted for 29 percent of the world production.
capacity overseas. Also it is suggested that economies of scale,
The East Asian Market with a population of more than 1.7 bil-
estimated to be 5 million annual production units for one
lion is categorized into four groups: Japan; Korea and Taiwan;
group, will be necessary for surviving in the coming environ-
ASEAN countries; and China. The general characteristics
mentally friendly and IT-oriented market of the 21st century.
are that Japanese and Korean automotive manufacturers are
In Japan only Toyota meets this criterion so far. As a result,
being restructured and realigned while Chinese and ASEAN
consolidation is advancing in the domestic market with distinct
markets with huge growth potential are attracting most of the
divisions along worldwide groupings so that Toyota, Honda,
major players from all over the world. More specific features
GM, Ford, DCM, and Renault groups are emerging and com-
are discussed below (see Exhibits 8 and 9).
peting against each other in Japan and abroad (see Exhibits 10
and 11).
Japan. Japan is a developed country and the domestic mar-
ket is mature with 11 automotive manufacturers. Production
Korea and Taiwan. In order to recover from the downturn
in Japan experienced its second straight year of decline in 1999
due to the Asian financial crisis, Korean manufacturers are
due to weak exports under the impact of the strong yen, and
now being restructured and realigned. Daewoo Motors has
due to a downturn in domestic sales. This trend has gradually

EXHIBIT 11
JAPANESE AUTOMOTIVE MANUFACTURER’S
ALLIANCES WITH WORLD MAJOR PLAYERS

European Japanese American

Daihatsu
51.2%
50%
VW Toyota NUMMI
Car supply 33.8% Car
Hino supply 50%

Suzuki 10%

Isuzu 49% GM

20% 49%
Fuji SIA
Isuzu
51%
100% 100%
Honda UK Honda Honda USA

34% 97.1%
DCM Mitsubishi MMMA
(Plan)

Ned Car 50% Parts supply Car

50% 5% each DCM supply
Volvo

36.8% 100%
Renault Nissan

22.5%
22.5% Nissan D. Ford
50%
Ford Car Mazda 33.4% AAI
supply 50%
in Europe
766 • Case 25 • DaimlerChrysler for East Asia

been the subject of intense offers from GM, Ford, Daim- groups and 6 to 7 middle size groups. The industry is not
lerChrysler, and Renault. Recently Ford received exclusive mature and the demand for trucks still strong (see Exhibit 15).
negotiation right from Daewoo’s creditors. Hyundai has also
taken a stake in Kia Motors. Taiwanese manufacturers suf- EXHIBIT 14
fered less because of a lack of investment in manufacturing TAIWANESE SALES
capability, and lack of an export-driven market. Both domestic
Capital Sales in
markets are getting mature (see Exhibits 12, 13, and 14).
Automaker Participation 2000
EXHIBIT 12 China Motor (Mitsubishi) 14.6% 35,348
KOREAN PRODUCTION BY Kuozui Hua Tung (Toyota) 46.6% 64,094
MAKE (THOUSAND CARS) Yue Loong (Nissan) 25.0% 72,733
1997 1998 Lio Ho (Ford/Mazda) — 45,331
San Yan (Honda) 13.5% 37,343
Hyundai 1,301 845
Kia 614 363
EXHIBIT 15
Daewoo 607 411
CHINESE PRODUCTION (THOUSAND CARS)
Daewooshop 156 248
Samsung 42 Market
Others 140 45 1998 1999 Share Alliance

Total 2,818 1,954 China First Auto 290 341 18.7%

Shanghai Auto 236 257 14.0% GM/VW
Dongfeng Motor 191 206 11.2%
EXHIBIT 13 Changan Auto 129 171 9.0% Suzuki
KOREAN MANUFACTURER’S ALLIANCES Tianjin Auto 155 115 7.0% Toyota
WITH WORLD MAJOR PLAYERS Beijing Auto 82 121 6.6%
Others 559 605 33.5%
American/European Korean Japanese
Total 1628 1830 100.0%

10% 1.4% EAST ASIAN MARKET OVERVIEW

DCM Hyundai Mitsubishi

100%
(Plan)
Kia
GM Daewoo
Alliances
Renault Samsung
Source: 1999 Nihon Jidosha Kogyo
ASEAN countries. Due to the Asian financial crisis in 1997,
the production in ASEAN nations, consisting of Indonesia,
Malaysia, Thailand, and India, decreased to 70 percent of
the peak level recorded in 1996. It may take 3 to 5 years
to recover to precrisis levels, even though each country is
seeking to stimulate domestic demand by changing policies
from protectionism to liberalization. Japanese manufacturers
dominate ASEAN countries, except Malaysia. However, the
markets still attract some major players due to the high growth
potential in these markets (see Exhibits 8 and 9 shown earlier).
China. Although most automotive manufacturers are inter-
ested in the huge potential of the Chinese market, it will
take some time to penetrate into the market mainly due to
the Chinese government’s strict control. The government sets
pricing limitations and regulations on local content and tariffs
to prevent ease of entry by outsiders. There are 2 to 3 big
As outlined, the East Asian auto market is quite diverse. In
this market several trends exist. First, there is the presence of
strong regional players like those in Korea. Second, East Asia
is home to several national car manufacturers like Malaysia’s
Proton. Third are the global brands and manufacturers in
Japan that not only have a history of exporting to markets
in East Asia but also have long-standing technical and equity
tie-ups throughout the region. Finally, until recently, is the
total lack of any significant presence by major American or
European manufacturers in the area. This has allowed exist-
ing regional players to consolidate their brand name and sales
channels in this market.
DAIMLERCHRYSLER’S STRATEGY FOR EAST ASIA
As Exhibit 16 shows, DaimlerChrysler’s vehicle platform and
sales pattern are extremely weak in East Asia. The Asian cri-
sis presented the opportunity to quickly change this without
forcing DaimlerChrysler into investing in costly ground-up
production and sales channel facilities, or an expensive acqui-
sition. Initially DaimlerChrysler pursued Nissan, but fear
over the actual extent of Nissan’s debt problems convinced
Schrempp to pass on Nissan. Honda was also considered,
but Honda’s desire to remain independent as well as the
potential for cultural differences scuttled the negotiations.
Convinced of the need for a partner Daimler initiated discus-
sions with Mitsubishi Motors in Japan. Mitsubishi seemed the
optimum partner due to its long-standing relationship with
Chrysler.
 Case 25 • DaimlerChrysler for East Asia • 767

EXHIBIT 16
DAIMLERCHRYSLER’S WORLDWIDE FOOTPRINT
Production Sales Revenue
Location Vehicle Type Locations Locations (Mil EUR) Personnel

North America Passenger Cars 1 508 9,180 1,898

Chrysler Group 41 5,167 59,766 125,549
Commercial 11 508 10,408 21,623
Vehicles
Total 53 79,354 149,070

Europe Passenger Cars 8 3,460 24,352 92,400

Chrysler Group 2 28 2,840 2,159
Commercial 15 3,460 13,728 55,327
Vehicles
Total 25 40,920 149,886
Asia Passenger Cars 4 629 3,101 328
Chrysler Group 3 25 409 420
Commercial 1 629 517 1,246
Vehicles
Total 8 4,027 1,994

South America Passenger Cars 1 466 350 1,330

Chrysler Group 4 23 780 1,254
Commercial 2 466 1,346 11,886
Vehicles
Total 7 2,476 14,470

Oceania Passenger Cars 197 266 0

Chrysler Group 5 134 0
Commercial 197 266 0
Vehicles
Total 0 840 0

Africa Passenger Cars 2 259 677 3,503

Chrysler Group 1 7 156 13
Commercial 1 259 430 0
Vehicles
Total 4 1,263 3,516

EXHIBIT 17
DAIMLERCHRYSLER’S PLANNED WORLD CAR PROJECT
Production Production Target Estimated Production
year Location Market Volume

First Half 2002 Korea (Hyundai) Korea 300,000 − 350,000

First Half 2002 Korea (Hyundai) China 100,000 − 150,000
Second Half 2002 Japan (Mitsubishi) Japan 100,000 − 200,000
2003 Europe (DaimlerChrysler) Europe 250,000 − 300,000
768 • Case 25 • DaimlerChrysler for East Asia
In March of 2000 DaimlerChrysler and Mitsubishi agreed
to a strategic purchase where DaimlerChrysler would acquire
34.4 percent of Mitsubishi for $1.86 billion. This will give Daim-
lerChrysler needed access to small car engine and platform
technology, and to existing sales channels. More importantly,
according to the March 27 joint press release, the strategic
purchase will mean that DaimlerChrysler Mitsubishi will have
a 10.4 percent market share in Japan and a 9.4 percent market
share in other parts of East Asia. Not satisfied with the Mit-
subishi deal DaimlerChrysler initiated a strategic tie-up with
Hyundai Motors of Korea. For approximately $486 million
DaimlerChrysler Mitsubishi will obtain a 10 percent stake
in Hyundai and a seat on its board. In exchange Hyundai
and DaimlerChrysler will engage in a 50:50 joint venture to
develop commercial vehicles and trucks for the Asian market,
and will develop a small car platform ‘‘world car’’ for East
Asian and other markets (see Exhibit 17). In two dramatic
moves DaimlerChrysler made significant progress in achiev-
ing its stated goal of increasing sales in East Asia to 25 percent
of total revenues.
DISCUSSION QUESTIONS
1. What are the strengths and weaknesses of Daimler-
Chrysler’s strategy?
2. How should DaimlerChrysler-Mitsubishi brand itself in
Asia?
3. What cultural issues will DaimlerChrysler have to over-
come to succeed with its strategy?