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Rebooting The Business In A Challenging Market Environment

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2

Introduction

Faced with a feeling of free-fall in an economic downturn, companies are challenged to understand recessionary dynamics and summon the courage to step up to the challenge of survival and growth

Succeeding during a recession requires “rebooting” how business is done. We consider example “reboots” through the lenses of changing consumer value perception, evolving distribution landscapes, pressure on price, and need for economical innovation

3

Introduction 1

Executive Summary 4

Recessions: An Opportunity To Create Significant Value 10

Four Opportunities To “Reboot” How Business Is Done 19

– I: Exploiting Changing Value Perceptions 21

– II: Conquering The Distribution Challenge 29

– III: Leveraging Smart Pricing and Promotions 44

– IV: Innovating With Limited Resources 51

Contents

4

Executive Summary

Deep into the recession, there is an opportunity and in some cases a necessity to fundamentally “reboot” the business

We have identified four recessionary dynamics which if properly navigated can lead to significant value creation and market position improvement

I. Exploiting Changing Value Perceptions

II. Conquering The Distribution Challenge

III. Leveraging Smart Pricing and Promotions

IV: Innovating With Limited Resources

Examples from the marketplace indicate significant benefits from rebooting

5

Executive Summary I. Exploiting Changes In Value Perception

During economic hardship, consumers may shift their perceived value of a product, affecting both segmentation and how competitors respond

We observe two forms of response to the shifts in perceived value

A Attacking Down the Value Line

B Attacking Up the Value Line

Scott Paper Towel

McDonald’s Coffee

Examples Market Lever

Clever companies can take share during the downturn by

– Identifying consumer changes in value perception, and

– Carefully managing product benefits to optimize both price and value perception

6

Executive Summary II. Conquering The Distribution Challenge

In a downturn, the economy impacts distributors differently, potentially altering the distribution landscape significantly

We observe four key threats posed by distribution networks in a downturn

Distributors May Act In Their Own Interest: Different types of distributors have different strengths and challenges, and may act selfishly against the interest of their suppliers

A

Channel Cost Differences Create High Switching Pain: There may be differing cost structures and service levels between different channels, making it difficult to nimbly shift between them

B

Differences Within The Channel Create Difficulty Diversifying: There may be differing cost structures and service levels within the same channel, creating difficulty in diversifying through them

C

Credit Availability Creates Low-End Channel Risk: Biases in credit towards higher-priced product channels (to facilitate purchase) create channel risk in tight credit markets

D

Dynamics in distribution are fundamentally changing. If left unchecked, the trend can significantly alter the outlook of a distribution-intensive company

Successful companies strategically adjust to distribution changes underfoot

7

Executive Summary III. Leveraging Smart Merchandising And Promotions

In a down-turn, companies face enormous downward pressures on price and, subsequently, profit margins

We observe five “smart” approaches to combat price reduction pressures

A Develop Value-Creating Product and/or Service Bundles

B Launch “Fighter Brands”

C Shift Channels to Reach Most Price-Sensitive Consumers

D Launch Targeted Promotions to Price-Sensitive Consumers

E Adjust to Higher Value Product Packaging

While price cuts may be necessary, successful companies respond to price pressures with smart marketing and merchandising strategies to avoid giving away the store

8

Executive Summary IV. Innovating With Limited Resources

Historical evidence suggests recessions are often a launching pad for breakthrough ideas

However, with increased revenue contraction, companies are challenged to generate meaningful innovations for the recession quickly and cost-effectively

We observe four approaches to reduce costs of innovations for both companies and their consumers

A Expand Network of Ideas and Establish Pay for Performance

B Replace High Cost Good Economy Services with Lower Cost Products

C Shift Capex to Opex

D Un-Bundle Products to Serve the Largest Volume Segments

Innovations are necessary to propel companies into post-recessionary economies

Successful companies find ways to maintain and get more from their “innovation engine” when faced with a downturn

9

Executive Summary

The following sections of this document will

– Highlight how recessions have historically represented periods of great opportunity to increase value and improve market position

– Review each of the four recessionary dynamics that we have identified and highlight how “rebooting” how business is done has enabled companies to excel in these challenging environments

– Provide a brief overview of Alliance and briefly summarize our field-ready programs which can help you reboot your business and thrive in these difficult times

10

Recessions: An Opportunity To Create Significant Value

Faced with a feeling of free-fall in an economic downturn, companies are challenged to understand recessionary dynamics and summon the courage to step up to the challenge of survival and growth

11

The U.S. Has Experienced 10 Downturns Since WWII

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

18

Real GDP Growth (%)

1948-1949

1953-1954

1957-1958

1960-1961

1969-1970

1973-1975

1980 1981-1982

1990-1991

2008-Now

2001-2003 Slow-down

12

Downturns Are Often Sparked By Weaknesses In A Key Sector Of The Economy

Asset Pricing Government

Macroeconomic Policy Foreign Funding

Corporate Economy Financial Systems

1953

• Restrictive

post-war

Fed

monetary

policy

1973

• OPEC value

destruction

through oil

pricing

2001

• Exchange

market

bubble

1991

• Sell-off in

foreign trade

• Savings and

loan collapse

2008

• Predatory

lending

credit crisis

1980

• Tight

inflationary

monetary

policy

The U.S. Economy

13

The Severity Of The Current Recession Has Important Implications

Deepening recession

Implications Impact • Dramatic pace and

magnitude of job loss

• Significant loss of

investor confidence

driving sharp declines

in capital markets

• Government

corrective influence

reaching near full

extent

• Continuing rise of

loan default rates

• Notable bankruptcies

and liquidation of top

ranked companies in

key sectors

• Further changes to

consumer purchasing

behavior likely

• Greater urgency to

access lowest cost of

capital

• Increased pressure to

lower prices to ensure

volume

• More imbalances

possible in supplier

and distribution

ecosystems

• Greater competition –

and therefore rapid

competitive playbook

changes – to serve

customer demand

• Higher probability of

witnessing innovative

responses

• Higher premium placed

on producers who

monitor and match

changes in demand

14

The Challenge Of The Economy Requires All Participants To Play Their Part

Increased consumer spending

Increased producer output matched to demand

Government corrective policy

Further loosening of financial system capital outflow

economic

transactions

15

"We are enjoying sluggish times, and not enjoying them very much.”

- George H.W. Bush

“When the going gets tough, the tough get going.”

- Joseph Kennedy

“When hard times hit, the singing, dancing and emotional ads go out the window, and companies say, ‘How do I nail my competitor?’” - Jack Trout

“Adversity has the effect of eliciting talents, which in prosperous circumstances would have lain dormant.” - Horace

“Brave men rejoice in adversity, just as brave soldiers triumph in war”. - Seneca

“Let me embrace thee, sour adversity, for wise men say it is the wisest course.” - William Shakespeare

The Advice Of History Is To Face The Challenge With Courage

16

0

20

40

60

80

100

120

140

160

180

200

220

240

260

0 2 4 6 8 10 12 14

Value-add By Industry In The U.S.1 1991 - 1994

Size: Employees (Millions)

Performance: GDP Value-Add Per Employee ($thds / employee)

GDP Value-Add

($B)

100

1Source:U.S. Bureau of Economic Analysis, Alliance Analysis; Excludes Government

200 300 400

700

500 600

1991 1994

Agriculture

Mining

Utilities

Construction Durable goods Mfg

Non-durable goods Mfg

Wholesale

Retail

Transport / Warehouse

Media and Software

Financial services

Prof. services

Education

Healthcare Recreation and arts

Food and Hotels Other

New Value Can Be Created By Industries During A Recession

Value-add by industry is the contribution of industries to the nation’s GDP

17

Recessions Offer An Opportunity For Players To Change Their Competitive Position

Source: Corporate Executive Board

111112

13

15

19

8

0

10

20

2.3x

1995 1994 1993 1992 1991 1990 1989

Percent of Firms Moving Up or Down at Least One Quartile in Market Cap to Sales Ratio (%)

Twice as many firms significantly changed their industry ranking relative to their peers during the 1990 recession

18

Reward For Leadership And Fast Action Is Very High

Apple iPod launched on October 23, 2001

“1,000 songs in your pocket” –exploits

market underserved with “big and clunky

or small and useless devices” – Steve Jobs

Revolutionized way music delivered to

end user

Sold 376K units in first year, 51.6M units

in FY2007

Starbucks Oatmeal launched

September 2008 with minimal

marketing support

By October 2008, despite warm

weather, oatmeal already best-selling

food item in Starbucks' entire system

“In tough economic times, comfort

foods such as oatmeal tend to see an

uptick.”

2001-02 Recession 2008-09 Recession

19

Four Opportunities To “Reboot” How Business Is Done

Succeeding during a recession requires “rebooting” how business is done. We consider example “reboots” through the lenses of changing consumer value perception, evolving distribution landscapes, pressure on price, and need for economical innovation

20

Overview

Deep into the recession, there is an opportunity and in some cases a necessity to fundamentally “reboot” the business

We have identified four recessionary dynamics which if properly navigated can lead to significant value creation and market position improvement:

Examples from the marketplace indicate significant benefits gained from rebooting

I. Exploiting Changing Value Perceptions

II. Conquering The Distribution Challenge

III. Leveraging Smart Pricing and Promotions

IV: Innovating With Limited Resources

21

Rebooting Your Business:

I. Exploiting Changing Value Perceptions

22

I. Exploiting Changes In Value Perception

During economic hardship, consumers may shift their perceived value of a product, affecting both segmentation and how competitors respond

We observe two forms of response to the shifts in perceived value

A Attacking Down the Value Line

B Attacking Up the Value Line

Scott Paper Towel

McDonald’s Coffee

Examples Market Lever

Clever companies can take share during the downturn by

– Identifying consumer changes in value perception, and

– Carefully managing product benefits to optimize both price and value perception

23

40

60

80

100

120

A. Attacking Down The Value Line Phase 1: Scott Paper Towel Initially In Loser Position Between Premium And Lower Quality Players

Customer Perceived Quality

Pri

ce

Pe

r S

hee

t In

de

x

Price vs. Consumer Perceived Quality Of Market

Private Label

Bounty

Scott

Private Label

Market Share Profits

Value line

24

20

40

60

80

100

A. Attacking Down The Value Line Phase 2: Scott Leverages Cost Differences To Find Winning Cost Position

Customer Perceived Quality

Co

st

Ind

ex

Competitive Cost Curves

Private Label

Losing Cost Difference

Winning Cost Difference

Can

Can’t

25

40

60

80

100

120

A. Attacking Down The Value Line Phase 3: Scott Maximizes Value At New Cost Position

Customer Perceived Quality

Pri

ce

Pe

r S

hee

t In

de

x

Price vs. Consumer Perceived Quality Of Market

Private Label

Bounty

Scott

Private Label

Market Share Profits

26

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

Liquid Concentrates Roast & Ground Espresso/Specialty

B. Attacking Up The Value Line Phase 1: Starbucks Innovates at the High-end

Coffee Quality

Pri

ce

Pe

r 8

oz.

Cu

p

Price Vs. Quality of Away-From-Home Coffee Products

Value Line

27

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

Liquid Concentrates Roast & Ground Espresso/Specialty

B. Attacking Up The Value Line Phase 2: McDonald’s Successfully Attacks High-end After Second Try, Buoyed by Economic Downturn

Coffee Quality

Value Line

McDonald’s creates attack ads to promote the new espresso beverage by exploiting general perception of Starbucks pricing

McDonald’s introduced Newman’s Own roasted by

Green Mountain

Pri

ce

Pe

r 8

oz.

Cu

p

Price Vs. Quality of Away-From-Home Coffee Products

28

B. Attacking Up The Value Line Phase 3: Starbucks Tries to Minimize Losses And Reformat

Starbucks Introduces Premium Instant Coffee For At-Home Market

Starbucks Bundles Coffee With Healthy Breakfast to Compete Against McDonald’s Perceived

Unhealthy Breakfast

Pri

ce

Pe

r 8

oz.

Cu

p

$0.00

$0.50

$1.00

$1.50

$2.00

Instant Grounds Pods Espresso *

Private Label Value Line

Brands Value Line

29

Rebooting Your Business:

II. Conquering the Distribution Challenge

30

II. Conquering The Distribution Challenge

In a downturn, the economy impacts distributors differently, potentially altering the distribution landscape significantly

We observe four key threats posed by distribution networks in a downturn

Distributors May Act In Their Own Interest: Different types of distributors have different strengths and challenges, and may act selfishly against the interest of their suppliers

A

Channel Cost Differences Create High Switching Pain: There may be differing cost structures and service levels between different channels, making it difficult to nimbly shift between them B

Differences Within The Channel Create Difficulty Diversifying: There may be differing cost structures and service levels within the same channel, creating difficulty in diversifying through them

C

Credit Availability Creates Low-End Channel Risk: Biases in credit towards higher-priced product channels (to facilitate purchase) create channel risk in tight credit markets

D

Dynamics in distribution are fundamentally changing. If left unchecked, the trend can significantly alter the outlook of a distribution-intensive company

Successful companies strategically adjust to distribution changes underfoot

31

A. Distributors May Act In Their Own Interest Phase 1: Harley Davidson Builds A Cohesive Dealer Network During Its Boom Years

Cohesive Dealer Group

“Boom" Years

Dealer Priorities:

─ “Grow with us”

Invest in infrastructure for growth

Enhance ownership experience

Capture P&A and GM potential

Implement good (basic) business practices

─ “Execute Harley Success Formula”

Keep objectives aligned

Build equity value

Conscious strategy to limit new dealers

• Similar size

• Similar

challenges

• Similar

strengths

• Two primary

strategies

• Similar

business

success

drivers

32

A. Distributors May Act In Their Own Interest Phase 2: Dealer Strategy Under Stress As Dealers’ Priorities Change And Begin To Differentiate

More dealers selling out

New dealers increasing

Multi-outlet ownership more prevalent

Dealer size spread widening

Rural vs. metro dealer distinction more noticeable

Cost advantages vary with size

Full Throttle

Cruisers

Transitional

Stragglers / Idlers

Growing Dealer Diversity Four Dealer Types Emerge

Unclear role of dealer for success

Dealer diversity requires more

tailored service and support

Dealers diverging H-D planning

Harley Davidson

Risk

Harder to generate growth under

H-D business model

Profit margins under pressure

Fixed costs not scalable

Dealer Risk

33

A. Distributors May Act In Their Own Interest Phase 2: Stress Accelerates The Predatory Competitive Behavior In The Dealer System

Transitional Stragglers / Idlers

Risk of ruin

H-D to the rescue?

Looking elsewhere?

Risk of provoking Power Shifters

Deterioration of brand

Cruisers

May become averse to invest and grow

Could sell to Power Shifters

Full Throttle ► Power Shifters

Strongest players

Could squeeze weaker competition

Could shift power balance with H-D

34

A. Distributors May Act In Their Own Interest Phase 3: Harley Realizes Need To Serve Its Dealers Differently

Full Throttle ► Power Shifters

Cruisers

Transitional

Stragglers / Idlers

Cap the discount rate to curb predatory behavior

Continue to serve status quo

Provide bailout loans to avoid irrational behavior Provide tools for proactive selling

Provide tools for proactive selling in a recessionary market

Harley Davidson Approach To Dealers Dealer Type

35

B. Channel Cost Differences Create High Switching Pain Phase 1: Acer Enters U.S. Market As Little Known Attacker

HP

Vendor Share

Retail

Sony

NEC

Others

20%

9%

7%

64%

HP

Vendor Share

Dealer / VAR

Lenovo/IBM

Fujitsu

Others

22%

12%

6%

60%

Dell

Vendor Share

Online

HP

Lenovo/IBM

Others

52%

13%

5%

31%

39%

7%

54%

• Failed U.S. entry

in the 1990s

• 100% indirect

channel strategy

• High reliance on

Circuit City and

Staples retail

accounts to

establish presence

• Enter at value PC

price point

2001 Total U.S. PC Shipments By Channel

36

B. Channel Cost Differences Create High Switching Pain Phase 2: Acer Establishes A Market Position Behind Dell And HP

HP

Vendor Share

Retail

Acer

Toshiba

Others

19%

5%

5%

70%

HP

Vendor Share

Dealer / VAR

Lenovo/IBM

Acer

Others

19%

14%

7%

61%

Dell

Vendor Share

Online

HP

Toshiba

Others

67%

8%

3%

21%

8%

40% 52%

2005 Total U.S. PC Shipments By Channel

• Acer adjusts strategy to focus on VARs and dealers for new growth

• Dell begins to pursue a VAR channel strategy

• HP rationalizes across channels

37

B. Channel Cost Differences Create High Switching Pain Phase 3: Acer Gains Market Share During Downturn As Dell Economically Bound To Shrinking Channels

Cost to Serve

Service-level

Electronics and Office Retail

Online Direct

Dealer / VAR

Acer profitability threshold

Dell profitability threshold

Dell exposed to high VAR bankruptcy during

recession

HP high exposure to Circuit City

Dell

Vendor ’07Q4 to ’08Q4 share gain/loss

HP

Acer

Apple

-4.1%

0%

+3.4%

+0.8%

Others -0.8%

Acer quickly shifts to back to retail channel

during downturn

Consumer And Small Business PC Channel Map

38

C. Differences Within The Channel Create Difficulty Diversifying Phase 1: ACCO Establishes A Diversified Retail / Wholesale Office Products Channel Base

Top Retail and Wholesale Customers

39

C. Differences Within The Channel Create Difficulty Diversifying Phase 2: As Staples Gains More Market Power, ACCO And Staples Part Ways Due To Unattractive Economics

ACCO Contribution

Margin

Demands lower prices

Requires higher supplier

customer services

40

C. Differences Within The Channel Create Difficulty Diversifying Phase 3: During Recession, ACCO Suffers With Their Remaining Key Partners

With Office Max forced into bankruptcy and Office Depot on the verge of bankruptcy,

─ ACCO stocks fell 95% within the 10-month period of summer 2008 to spring 2009

─ ACCO brands asks lenders to relax covenant restrictions

─ Moody‟s drops ACCO‟s credit rating to BBB from B in February 2009

ACCO competitors who remained cost competitive with Staples did not feel brunt of

impact

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Office Max

Staples

Office Depot

ACCO

Index Of Select Office Product Monthly Stock Closing Prices (9/1/2005 = 1.0)

9/1/2005 2/1/2009

41

Price

Customer Segment

Mass Premium Buyer Luxury Buyer

D. Credit Availability Creates Low-End Channel Risk Ashley Furniture and Ethan Allan Established Themselves As Leaders In Respective Furniture Price Segments

Primary sales channel: Hundreds of independent dealers with exclusivity-contracts and rights to use supplier brand name

42

D. Credit Availability Creates Low-End Channel Risk Credit Crisis Begins Favoring Dealers Serving High-End Clients With Better Credit Histories

Services

Customer Segment

Mass Premium Buyer Luxury Buyer

Showcase dealers

Big Box Retail

Ind. Dealers

Rent-To-Own

Flow of Credit

Key players out of business (e.g. Levitz,

Rhodes, Wickes)

• GE Capital cut all furniture

inventory financing in May „08

• Ashley CEO response:

“…devastating to a lot of our

dealers”

• Ethan Allen CEO response:

“We have yet to see any signs

of a decrease in customer

credit lines or approvals…Our

client base, we‟re told, has one

of the best credit histories”

High number of local chain and mom-and-pop bankruptcies in segment

43

D. Credit Availability Creates Low-End Channel Risk Ashley Furniture Forced To Survive Recession Via Focus On Rent-To-Own Channel

Services

Customer Segment

Mass Premium Buyer Luxury Buyer

Showcase dealers

Big Box Retail

Ind. Dealers

Rent-To-Own

• Ashley Furniture hosts the

association of rental dealers

at largest U.S furniture market

• Sponsor “How-to

seminars” on selling in a

recession

• Help dealers coordinate

furnishings to create

consumer appeal

44

Rebooting Your Business:

III. Leveraging Smart Merchandising and Promotions

45

III. Leveraging Smart Merchandising And Promotions

In a down-turn, companies face enormous downward pressures on price and, subsequently, profit margins

We observe five “smart” approaches to combat price reduction pressures

A Develop Value-Creating Product and/or Service Bundles

B Launch “Fighter Brands”

C Shift Channels to Reach Most Price-Sensitive Consumers

D Launch Targeted Promotions to Price-Sensitive Consumers

While price cuts may be necessary, successful companies respond to price pressures with smart marketing and merchandising strategies to avoid giving away the store

E Adjust to Higher Value Product Packaging

46

A. Develop Value-Creating Product And/Or Service Bundles PetSmart Drove Growth Through Service Expansion

In 2005, brick and mortar/online retailer PetSmart launched PetsHotel in 2005, now available at over 90 locations

PetSmart pursued strategy of becoming conduit for all the services required for pet owners, including training, grooming, and health care

– Continually expanding training, grooming and veterinary services to more stores

Offering services in addition to products allowed PetSmart to

– Differentiate itself from competitors

– Drive traffic and repeat visits to stores

– Forge stronger relationships with customers

– Provide cross-selling opportunities

– Increase transaction size

– Enhance operation margin

Lower cost structure and convenience compared to traditional local outlets for pet services contribute to a compelling value for price-conscious pet owners

– Strategy yielded significant revenue growth of over 10% in 2008

– Pet services net sales grew by 22%, 26%, and 24% in 2007, 2006, and 2005, respectively

47

B. Launch “Fighter Brands” Major Brands Protect Share By Introducing A Fighter Brand

Core Brand Fighter Brand Context

Facing a slew of low-cost competitors, introduced a discount bus line, Bolt Bus, in a joint venture with Peter Pan

Reports indicate high popularity in initial regional launch in Northeast

Proctor and Gamble launches luxury diaper brand, Pampers

Private labels begin to threaten Pampers’ market share

P&G launches lower-price brand, Luvs, to fend off private label

Brand launch proved so successful that P&G keeps Luvs as a permanent mid-price brand

Kao Corporation launches cheap private label diskettes

3M maintains price premium on core brand and introduces Highland diskettes at competitive price point

Quality-driven consumers continue to buy 3M disks

Price-driven consumers split between Kao and Highland

3M maintains high margin on branded disks while also capturing a portion of low-margin private label market

Consider introducing a “Fighter Brand" — a low-priced version of the flagship product, sold under a different name — that will satisfy the appetites of price-conscious consumers without devaluing the brand equity of the Core Brand, while meeting the value needs of consumers in a downturn

48

C. Shift Channels To Reach Most Price-Sensitive Consumers Apple, Starbucks Shift To Value-Oriented Channels

Sales of iPhones began to slow in a weak economy

Apple and AT&T reached a deal with Wal-Mart in December 2008 to sell the phones at the discount retailer

Despite only offering a $2 discount off the $199 phones, channeling through a discount retail channel enhanced the value perception of the phone for consumers

Starbucks Via launched in Starbucks stores, Costco, and Target in early 2009

Channeling product from traditionally high-end coffee brand through discount stores highlights its value proposition and reaches target consumers, newly price-conscious coffee aficionados

49

D. Launch Targeted Promotions To Price-Sensitive Consumers DirecTV Seizes Opportunity, Market Share

In 2009 recession, DirecTV launched promotional strategy rewarding high-value subscribers as well as new subscribers

– Loyalty rewards for high-value customers (e.g., free upgrades) helps ensure their continued use of DirecTV

– Special introductory offers capitalize on newly price-sensitive consumers, spurring switching

DirecTV maintained prices for most customers, did not sacrifice brand equity, and gained share

– Added over 300,000 subscribers in Q4 2008 alone, and increased operating profits over 2007 by 20%

50

E. Adjust To Higher Value Product Packaging Major Food Manufacturers Tailor Packaging To Consumer Behavior

In mid 2008, commodity prices rose dramatically

General Mills adjusted packaging of many products, including Cheerios, to keep prices stable

– Customers report being much more sensitive to prices than to product size

General Mills maintained profit margins on Cheerios while still offering cereal at a price point comparable to competitors

– Cheerios’ resultant revenue growth (9.6%) and unit growth (10.5%) still outpaced industry growth (2.8% and 1.1%, respectively)

In recession, increasing number of people are living paycheck-to-paycheck

– Consumer purchases increasingly driven by the paycheck cycle

Registering relatively strong sales in the beginning of the month, and weaker sales toward the end of the month, PepsiCo’s FritoLay adjusted promotion planning to coordinate with customer needs

– Promoted larger sizes at the beginning of the month

– Promoted smaller sizes at the end of the month

– Approach declared a success by PepsiCo CEO John Compton

51

Rebooting Your Business:

IV. Innovating With Limited Resources

52

IV. Innovating With Limited Resources

Historical evidence suggests recessions are often a launching pad for breakthrough ideas

However, with increased revenue contraction, companies are challenged to generate meaningful innovations for the recession quickly and cost-effectively

We observe four approaches to reduce costs of innovations for both companies and their consumers

A Expand Network of Ideas and Establish Pay for Performance

B Replace High Cost Good Economy Services with Lower Cost Products

C Shift Capex to Opex

D Un-Bundle Products to Serve the Largest Volume Segments

Innovations are necessary to propel companies into post-recessionary economies

Successful companies find ways to maintain and get more from their “innovation engine” when faced with a downturn

53

A. Expand Network Of Ideas And Establish Pay For Performance P&G’s Open Innovation Model

By 2000, P&G’s invent-it-ourselves model was not capable of sustaining high levels of top-line growth

– Innovation success rate had stagnated at 35%

– Squeezed by competitors, flattening sales, lackluster new launches, and quarterly earnings misses, P&G lost more than half of its market cap when stocks slid from $118 to $52 per share

A.G. Lafley was appointed CEO, who launched an open innovation model. He set the long-term goal to source 50% of all “discovery and invention” from outside the Company. Example success stories include:

– Olay Regenerist - At a technical conference in Europe, P&G first learned of a new peptide technology that would soon be a key component in is blockbuster product, Olay Regenerist. P&G continues to partner with the small French company on products in its $2B beauty brand

– Bounce – P&G introduced Bounce, the world’s first dryer-added fabric softener from an independent inventor in Canada. The inventor had developed the innovative technology working from home and patented it. P&G licensed the technology from him and combined it with the work of P&G researchers, resulting in Bounce

– Crest Spinbrush – Partnered with, then acquired Dr. John’s, maker of SpinBrush, to capture 50% marketshare of the growing powered-brush category in the US

– Mr. Clean Magic Eraser – A P&G technology entrepreneur discovered a stain-removing sponge for sale by German chemical company BASF in Osaka, Japan. He sent the product to the company for evaluation and posts an evaluation of market performance on P&G’s internal “eureka catalog” network. P&G negotiated with BASF to launch the product in Europe and the US and collaborated on future Magic Eraser products

Today more than 35% of new products come through the labs rather than from the labs, up from 15% in 2000, and 45% of initiatives have key elements that were discovered externally

– R&D productivity has increased by nearly 60%. The innovation success rate has more than doubled and cost of innovation has fallen

– P&G regularly sponsors and leverages innovations outsourcing companies to tap into a wide network of scientists and inventors for key areas of development. Winning ideas receive rewards

54

B. Replace High Cost Services With Lower Cost Products Crest Whitestrips Replaces High Cost Vanity Dental Services

After introducing the Total toothpaste in 1997, Colgate overtook Crest as the leader in the oral care market

– The Total product launched a $500 million industry by 2000

– Colgate gained more than 34% of the toothpaste market in the US

– Crest, the previous category leader, slipped to 29%

During the 2002-2003 recession, P&G saw an opportunity to use chemical dissolvable strips technology (from P&G labs in non-related food wrapping category) to lower consumer cost of tooth-whitening services

– $30-$50 million tooth-whitening market

– Dentist-administered tray process cost: $300-$1,000

– The Crest Whitestrips, when first introduced cost $44 for two-weeks supply

P&G credits Whitestrips for helping Crest overtake Colgate as the leading oral care brand in North America

– Crest Whitestrips created new category for home teeth whitening products and dominated 75% of the category

– Crest Whitestrips generated $250 million in retail sales in 2003 and has maintained a healthy growth rate since

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C. Shift Capex To Opex SalesForce.com’s Cloud Computing Business Model

Overall technology spending slow-down after the 2002 dot-com bust

– Tech companies, especially software, struggle to maintain enough revenue growth and EBITDA margins to justify stock valuations

– Rapid commoditization of hardware sales as products standardized, squeezing margins on hardware companies

– Total cost of ownership for IT systems increasing as more complex IT systems and therefore more IT services needed to stay competitive. Only large enterprises could afford this approach

SalesForce.com innovates cloud computing model (applications built specifically for Internet delivery) as a way to shift capital IT spending to operational on-demand IT spending, especially for mid-market

– One-to-many delivery ensures scaling of hardware resources across multiple customers, rather than one box for one customer

– Software licensing, maintenance, and hosting prices bundled together

– Software hosted off-site, requiring no on-premise resources

– Overall EBITDA margins for cloud computing lower than traditional packaged software, but lower TCO for customers drives volume growth higher

Cloud computing model reinvigorates technology industry

– New category of software created – Software-as-a-Service

– 20%+ CAGR growth in cloud computing spending (though only 5% of total software spend)

– Inspires cloud computing solutions from Microsoft (One Care), IBM (managed desktop), McAfee (anti-virus solution), Cisco (managed network), WebEx (hosted meetings), Postini (anti-spam)

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D. Un-bundle Products To Serve Largest Volume Customer Dow Corning’s Market-Based Pricing B2B Solution

Dow Corning was established leadership in B2B silicon-based technology products, though struggled to compete in rapidly commoditizing silicon products markets by 2001

– Existing model based on high services component, creating loss of share with largely price-sensitive customers

– Dow looking for a way to recapture and retain price-sensitive silicon customers without cannibalizing existing business

Dow Corning takes strategic measure to actively listen to customers, speak with industry experts, and learn from B2C delivery models. Led to the 2002 launch of a separately branded web-based channel (Xiameter) for convenient, no-frills, economical product purchases

– Market-based pricing business model

– No technical services, not even for a higher price

– Strict and transparent rules for lot sizes, delivery times, and pricing/payment terms

– Minimal channel conflict – can buy the same products from Dow Corning or local distribution with more service elements at a higher price

Largely successful business model innovation helped re-establish Dow leadership in silicon products market for the current times

– Profitable after 4 months based on new business alone

– In 9 months, double digit revenue growth