STRATEGY ONLINE

Closely Held Businesses and
the World of Gumption Traps - Part II

Case Studies

Cousins Unlimited

1. Situation Summary

Cousins Unlimited was founded by Alfred Smith in 1921 near Fort Smith, Arkansas. It specialized in furniture which was strong, functional and mid-priced. A fairly significant portion of sales was direct sales to schools, hospitals and other institutions. The remainder was direct to regional department stores and independent furniture retailers. The Company had been organized into two divisions - Case Goods and Upholstered – both divisions with multiple manufacturing and assembly facilities. Grandpa Al was well-loved in the community and he gave countless hours to the community while his Company prospered under the watchful eye of his Senior Vice President, Thomas Robinson.

He raised two children and when Al, Jr. became 38 years old Grandpa Al turned the business over to him. He also made certain gifts of stock to his daughter, Sara Smith Allen, and grandchildren. He felt strongly that Al, Jr. should run the business and be in complete control and accordingly gave Al, Jr. the vast majority of the “voting stock” with other family members getting non-voting.

The furniture industry proved to be a lot tougher in the 70’s and 80’s than in the early hey day. Tom Robinson, who made everything “look easy”, had retired. Al, Jr. had a few surprises and pitfalls but struggled fairly successfully until the mid-80’s. His nephew, Nicholas joined the Company in 1978 right out of college. He possessed the jovial good nature of Grandpa. Al, Jr.’s four children each professed “no interest” in the Company until the youngest child graduated from the University of Texas Business School. At age 30, he arrived and said “I’ve always loved this business.” He possessed the following assumptions:

  1. I am Al, III; Dad owns all the voting shares and someday those shares will be mine.
  2. Running a business that is already successful will be easy. Grandpa Al didn’t work very hard.
  3. I’ve always loved this business. I just forgot to tell anyone.

In 1988, Al, Jr. strengthened the marketing and sales organization by hiring Bob Prendergast, an accomplished industry veteran. Prendergast proceeded to restructure the sales function, brought in additional talent and instituted a formal sales training program. The results were impressive. Turnover stopped, professionalism as perceived by customers rose, and several large new accounts were won. By the early 90’s, sales were growing at two times the rate for the industry.

Unfortunately, the Company continued to lose money, suffering operating losses in five consecutive years. The only good news was that management believed momentum was on the upswing, with a small operating profit reported in the most recent year to break the string of losses.

Nicholas’s sister Alice recently worked at the Company as a summer intern before her second year at UVA Business School. She wanted to come to work for the Company and in fact, possessed impressive financial skills and experience, but would not consider it under the current facts. Among other things, she referred to the Company’s ownership structure. The stock was held as follows:

Family # Non Voting # Voting Total # Share
Allen Family
     
Alfred R. Smith, Jr. 5,002 2,075 7,077
  His children:      
Alfred R. Smith, III 2,442
2,442
CSF 2,442   2,442
BSB 1,442   1,442
FSL 1,442   1,442

Total Smith Family 12,770 2,075 14,845
 
Allen Family
     
Sarah Smith Allen 6,285 610 6,895
  Her children:
     
Nicholas Allen, Jr. 2,650   2,650
Alice Allen 2,650   2,650
TA 2,650   2,650

Total Allen Family 14,235 610 14,845

Al, Jr. was rarely seen at the company before 10:30 AM. In the most recent year, he and Al, III purchased a new company outside of the Cousins Unlimited structure. This new venture manufactured recliners and vibrator chairs and had been losing money for years. It began purchasing key subassemblies from Cousins Unlimited on special payment terms.

The financial results of the new venture were disastrous. Some of the cousins were getting restless. Seeing an attorney was no longer considered an unacceptable option. The local Bank was even more restless. Senior bank officials asked for a detailed plan of action. Of particular concern was the performance of one division, upholstered furniture, and the impact of the new venture. Cousins Unlimited owed the bank several million dollars and was in violation of various loan covenants. The new business venture owed Cousins Unlimited in excess of two million dollars, while its losses continued to mount.

2. Sales History
See Exhibit 1. Combined sales of both Divisions A and B had grown from $50 million in year one to about $76 million in year eight, an average compound growth rate of 6.2% per year. Division A, which contributed 40% of total company sales in year one had grown faster, 9.5% per year, reaching 50% of total company sales in year eight.

3. Quantitative Danger Signs

  1. Poor Operating Performance Compared to Industry Peers. See Exhibit 2. The company’s poor performance versus its peers went far back into time. While it made an operating profit in year eight, its first in six years, the level of profitability was still consistently below the industry average.

  1. One Division Significantly Out Performing the Other. See Exhibit 3. Division A, despite having grown to 50% of total company sales by year eight, delivered just 33% of total division profit, before accounting for corporate expenses.

  1. One Division Actually Losing Money. See Exhibit 4. The division profit margin for Division A had been consistently below that needed to cover its share of corporate expenses. Yet, it is the division that was growing the fastest.

  1. Excessive Number of Very Small Customers. See Exhibit 5. More than one-half of Division A’s customers were contributing only 5% of the sales from each plant.

  1. Chronically Poor Operating Cash Flow. See Exhibit 6. The financial condition of the company had been dramatically weakened by years of operating losses and declining asset productivity.

4. A Diverse Group of Shareholders
Al Smith, Jr.’s children, with the exception of Al, III, seemed resigned to their stock having little value. Sarah Smith Allen and her children were becoming increasingly more vocal over their dissatisfaction with the company’s habitually poor performance. The era of avoiding confrontation of people and issues was coming to a close.

5. The Solution

  1. Brought in a new CEO. An analysis of the existing management led to a recommendation to hire a new CEO with a five-year contract; part of his or her charge was to recommend a successor, with the goal of naming a family member. The new CEO was required to supervise the three cousins and help develop their individual talents. Alice was hired as Chief Financial Officer and Al, III and Nicholas continued as Vice Presidents with carefully defined areas of responsibility. Al. Jr. heaved a great sigh of relief and assumed the office of Chairman of the Board. At the request of friends in his local church, he embarked on a campaign to become Moderator of the General Assembly of The Presbyterian Church, U.S.
  2. Effected Recapitalization. All common stock was exchanged for two new classes of common, each with voting rights. The non-participating shareholders received Class B common which was redeemed over a four year period. Through family transfers, Class A Common stock ended up 25% to Al, III, 25% to a family partnership with Al, Jr. as General Partner, 25% to Alice and 25% to Nicholas.
  3. Wrote-Off Investment. The disastrous Vibrator Chair business was put out of its misery and the receivable to Cousins Unlimited was written-off.
  4. Downsized Division A and Invested to Grow Division B. The downsizing included the closing of two plants and the elimination of many unprofitable customers and market segments. Although the lay-offs were painful, everyone agreed that employee morale quickly rose to an all-time high.

Commodities ‘R Us

1. Situation Summary

Neil Kelly, Sr. had come to America as a teenager during the 1920’s, settling with his family in the Chicago area. He grew up working in the meat business for a variety of companies and in the early 1940’s opened his own plant under the name Kelly & Son Meat Packing. The company was successful for over twenty years, primarily providing sausage-based meat products both under its own brand name as well as a subcontractor for other well-known branded products. Customers were supermarket chains, grocery distributors and all of the independent family owned food markets which thrived in the Chicago area. Mr. Kelly, Sr. had the happy-go-lucky personality of his Irish ancestors and was at his strongest roaming the plant interacting with rank and file employees. Turnover was very low and the word had spread that Kelly & Son was a great place to work.

His son, Neil, Jr., began working in the family business while still in junior high school, but it soon became clear that working in the plant or on the shipping docks was not his strength. He was a natural born salesman, loved being out of the office, on the road and interacting one-on-one with the customers. His sister, Kate, worked in the office but after marrying, showed a declining interest in the business.

Mr. Kelly, Sr. died suddenly in late 1960’s, leaving seventy percent of the stock to Neil, Jr. and thirty percent to Kate. Neil, Jr. became President and Chief Executive Officer. For a time the company continued to grow successfully. Neil, Jr.’s legendary sales skills were resulting in new accounts every year. But he was spending less and less time inside the Company and morale, especially in the plant, began to slip. Union activity was becoming prevalent around other plants in Chicago. By the late 1970’s Kelly & Son had been forced to fight two union organizing efforts, winning both but by narrow margins.

Profit margins were being squeezed by two factors. First, labor costs were rising faster than sales. Second, Neil, Jr. had been developing a whole new category of business for the company – producing store-brand products for the large independent and national food store chains. Volume was growing in this new product line, but margins were substantially less than the branded products upon which Kelly & Son was built. By 1978 operating profit was less than interest expenses. Neil, Jr. decided that to survive, the company would have to move to an area of lower labor costs. Accordingly the move to central Alabama was completed successfully in 1979.

The company’s fortunes reversed and it enjoyed a number of years of rising profitability and labor stability. In 1985 Neil, Jr. attracted one of the industry’s finest Sales and Marketing Vice Presidents, Pete Gibson, from a competitor. Pete and Neil became a good team and the Company continued to grow. Also at this time Kate expressed an interest in selling her thirty percent of the Company. On the advice of the Company’s attorney, accountant and bank, an ESOP was created to purchase Kate’s shares. In 1987 Neil made another important personnel addition as Hank Trumbull joined the Company as Controller. Hank had an industrial engineering degree from Virginia Tech and after working on factory floors for a number of years, went to business school at the University of North Carolina at Chapel Hill. Neil had in the back of his mind that perhaps Hank would someday take over as CEO.

By the mid-80’s competition intensified as the buying power of large retail food chains increased substantially. Neil, Jr. loved the interaction and the bantering with the buyers and purchasing managers, and was convinced the future of the Company depended upon increasing the business with these power-house customers. He had even changed the name of the company: Kelly & Son became Commodities ‘R Us. In the late 80’s one large competitor withdrew from the business, presenting what Neil, Jr. felt was a once-in-a-lifetime opportunity to accelerate the growth of Commodities ‘R Us by obtaining new business with this competitors’ accounts, many of which were “mega chains” he had been trying to crack for years. Now these accounts were actually calling Kelly asking how much of their business he could handle! Gibson and Trumbull developed the new operating plan for accomplishing the increased growth. Among other things, the plan included an additional $5 million borrowing on the Company’s line of credit to finance the higher working capital requirements.

While Neil was criss-crossing the country growing the large chain business, morale inside the Company was slowly but steadily deteriorating. Turnover was increasing. While operations had been marginally profitable throughout the recent period, the Company failed to meet plan for three consecutive years. One of the consequences of the shortfalls was no bonuses for Gibson and Trumbull. Debt was increasing and the resulting interest costs actually created a pre-tax loss in the most recent year. The last two ESOP evaluations showed declining stock values.

Both Gibson and Trumbull were noticeably frustrated, and Trumbull in particular seemed to be losing interest. What had been a close-knit threesome had become a fragmented group of individuals without a common direction. A recent survey of customers had suggested that Commodities ‘R Us was suffering from a confused image in the market place. Neil’s wife Suzanne, an outspoken and capable member of the Board was strongly lobbying her husband to reduce his work and travel schedule, and withdraw from day to day management.

The bank continued to be supportive despite the lackluster results. Though the Company was in technical violation of certain ratio covenants, the bank was eager to increase the line of credit to support the proposed expansion. The loan officer had even raised the possibility of financing an acquisition to increase capacity.

Suzanne thought the bank was crazy and that the Company was teetering on the brink of financial catastrophe. Not afraid to speak-up, she had expressed to the Board, which included two strong independent directors and Neil, her opposition to expanding the private label business further if such expansion meant more debt. She had confided in others her belief that the Company needed new blood in senior management. Pete Gibson had also stated privately, “We’re in no man’s land. We need to get serious about making some major changes or this company is headed for real trouble.”

2. Quantitative Danger Signs]

  1. Severe Selling Price Deflation on Certain Products. See Exhibit 7. Industry over capacity and intense competition had been unrelenting for six years. Selling prices of certain key private label products were from 2% to 22% below their levels in year one.

  1. Disappearing Gross Margins, in Several Key Products. See Exhibit 8. Only one of the five private label lines produced a gross margin that was close to acceptable. Two products were actually losing money at the gross margin level.

  1. Misallocating Resources Among Product Categories. See Exhibit 9. The total private label product lines were almost 40% of the sales, consumed one-half the labor and machine resources, but generated one-eighth of the gross profits.

  1. Gearing Up to Satisfy the New National Accounts. See Exhibit 10. The plant manager had been instructed to plan for significant volume increases for the leading private label products.

3. The Solution

  1. Named Pete Gibson President and Chief Operating Officer. Neil, Jr. moved up to Chairman, and cut-back dramatically his day-to-day involvement. Neil and Suzanne went on a long vacation soon after the Gibson announcement.
  2. Reduced Commitments to Supply Commodities to New Retail Accounts. The substantial reduction of these commitments was accomplished through high-level negotiations spearheaded by Kelly and Gibson.
  3. Dropped Notoriously Unprofitable Customers that were Purchasing Only Unbranded Products.
  4. Identified and Pursued Candidates for a Strategic Alliance. The objective was an alliance with a focused commodity producer that needed CRU’s national account relationships, thus permitting CRU to devote its plant to branded products.
  5. Strengthened the Plant’s Capabilities to Manufacture Specialty Branded Products. The company targeted two specialty product categories it intended to dominate.
  6. Communicated New Direction to All Employees. Presentations of the strategy were made by Gibson to all employees. Each employee carried a printed laminated card containing the new mission Statement and strategic goals.
  7. Recruited a new Vice President of Marketing with Experience in Specialty Branded Products.

Spouses Express

1. The Situation Summary
The DiAntonio family came to eastern Tennessee in 1915. Grandfather Carlo was a stone mason with three children, the youngest of whom, Vincent, was an entrepreneur right from the beginning. Through a succession of shrewd investments and business deals, Vincent accumulated a substantial net worth by age thirty-five. He and his wife Rose-Marie had six children, three girls and three boys. The two youngest, sons Anthony and Michael shared their father’s interest in business. Michael in particular exhibited many of his father’s entrepreneurial and natural leadership talents.

Around 1970 Vincent purchased a failed metal fabrication plant at a bankruptcy auction and began immediately to refurbish and re-outfit the facility. He renamed the company Spouses Express and proceeded immediately to rejuvenate the business. The two boys began working in the Company while in high school.

Spouses Express designed, built and installed custom metal signs, primarily for independent and regional family restaurant chains throughout a number of Southeastern states. Customers were lower/mid to mid-priced independent and regional chains such as Waffle House, Krispy Kreme, Pancakes Galore and Captain Jack’s. By 1980 sales had been rebuilt to over $20 million, and Spouses Express was considered number one in its industry.

Anthony was the sales and marketing talent, and was at his best in front of customers. He could instantly translate a customer’s need into the design of a product, and was well known throughout the trade associations of which customers were members. He had graduated from the University of Tennessee, married Frances Higgins and had two daughters. The youngest daughter, Angie, worked at Spouses Express as a product designer.

Michael had not finished college, dropping out in his sophomore year to come full-time into Spouses Express. His strength was in the operations and manufacturing. He was generally given credit for state-of-the-art facility. He and his wife, Emma, had three sons, two of whom were working in the Company. One covered two states as a salesman. The other was coming up through the ranks in the manufacturing organization. Both were in their twenties with hopes of advancing in the business.

Vincent had left the Company entirely to Anthony and Michael. Each owned fifty percent of the stock while none of their four older siblings were involved in any way. Anthony and Michael worked well together for years. But things began to change during the mid-1980’s. Anthony was devoting more and more time to outside interests, including state-wide politics and a variety of charities. Frances had inherited substantial assets of her own and the couple enjoyed traveling in social circles consistent with an upscale life-style. Consequently, Anthony spent less time supervising the sales force and several salesmen were beginning to complain privately to Michael about his lack of attention.

The strain between the families increased in the late 1980’s. The decision was made to expand the business by designing and building the actual restaurant structures. As part of the necessary financial package, the bank required personal guarantees, not only from Anthony and Michael, but also each wife. Frances, in particular was extremely uneasy but succumbed to the pressure from both Michael and Anthony to sign the guaranty agreement.

While customers were thrilled with the company’s expansion, the start-up did not go well. Technical and field installation problems had resulted in costly delays, operating loses and a strain on the company’s finances. The bank had become concerned enough to call in its Special Assets Division. After a year of tense and often bitter confrontation with the bank the brothers reluctantly agreed to partially downsize the business as a condition of restructuring the loans. Operations began to improve and the bank, while still believing that the Company was undercapitalized, was less concerned about its short-term exposure.

The relationship between Anthony and Michael continued to deteriorate. Michael accused Anthony of waffling, of being unwilling to take a stand on any issue so that he could later second-guess everything. He also accused Anthony of neglecting his responsibility to manage the sales people. Sales force turnover had increased. Anthony’s absenteeism and outside interests also had become a great sore point with Michael. On the other hand, Anthony claimed Michael was a hip-shooter, made decisions too quickly without proper due diligence and consideration of the long-term risks, and tolerated incompetent friends in plant management. Anthony and Frances believed Michael forced them into accepting the decision to expand into the new product line and personally guaranteeing the debt. They also believed that Michael’s management style was directly responsible for the start-up problems which had brought the Company to the brink of bankruptcy.

The morale of non-family key executives was poor. The management team seemed unable to make even the simplest decisions, as every matter brought before the group degenerated into a stalemate between Anthony and Michael - Anthony saying, “I told you so” while Michael lamenting “You are interfering with everything I am trying to do.” Several chief financial officers had quit and a key regional sales manager threatened to leave.

On a number of occasions during this period, Anthony had said he wanted to sell his interest, pay his debts, and devote the rest of his career to his outside interests. Several times, potential transactions seemed ready to close only to have Anthony back down at the last minute saying he had changed his mind, was going to get more involved again and “straighten this company out.” But it never lasted.

The tension between Frances and Anthony and Michael was mounting. Michael and Frances had had to be physically kept apart during the first closing of the restructured financial package. Another loan package renewal was only months away when Frances made it very clear to both men she would not be “coerced or threatened” into signing any more personal guarantees.

2. The Solution

  1. Elevated Anthony to Chairman and appointed new Vice President of Marketing from within the Company. Frances was actually instrumental in convincing Anthony to go along with the Plan.
  2. Reinstituted negotiations to sell Anthony’s interest in the Company. A qualified investor group that had expressed interest in the past and was compatible with Michael came forward. This time a transaction was completed. The Company also benefited by the resultant infusion of new working capital and a new CFO.
  3. Strengthened Management in the Modular Building Arena. Needed steps were taken which had been impossible previously because of the conflict between Anthony and Michael.
  4. Strengthened the Field Sales Force. The new Vice President of Sales became an active hands-on leader, something badly needed and welcomed by the sales force.
  5. Made it Possible for Anthony and Michael to become friends again. Michael tearfully commented that the cloud lifted during the closing of Anthony’s stock sale. Brothers, brothers’ wives and cousins began to enjoy each other again in non-business settings.

Procrastination and Consequences
Successful Leadership Teams and the Energy / Entropy Balance
Seizing the Moment: Is Now the Time?
Entropy, Energy and the Implications for Change in Family Businesses

The Board As An Intangible Asset

From Pasadena to Panama

How to Grow with What You Have

The Transformational Turnaround

Offshore Outsourcing May Be In Your Company’s Future

Dealing with Uncertain Times

Economics and Nonprofits: Safeguarding the Mission

From Seasons Such As These

Corporate Accountability, Culture of Openness Yields Results

Board of Directors Is Key Tool for Success of Private Companies

Ladies and Gentleman, Start Your Engines

Closely Held Businesses & the World of Gumption Traps - Part I

Closely Held Businesses & the World of Gumption Traps - Part II
 
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