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Learn to Expect the Unexpected in Global Retail Expansion

Taking a proven retail model and exporting it to a new country, often with a new set of competitors, a different language and culture, and unique shopper expectations requires more than just market research before entry.

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Global retail expansion has attracted many followers. These include small to medium-sized companies, some new to international expansion, and others in more mature organizations. The success of newer, specialty retailers in the international market, such as Zara (Spain), H&M (Sweden), and Shanghai Tang (Hong Kong) have paved the way for others to follow. Perhaps surprisingly, a number of well-known retailers have failed to succeed in certain global markets due to a variety of reasons. These include regulatory, legal and cultural challenges, competition, and trying to change shopping behavior. The purpose of this article is to analyze the successes and failures of retailers who, seeking future growth, have entered global markets, and to offer lessons learned for future global enterprises to maximize their chances of success.

Even the Biggest Retailers Can Falter

Walmart, considered the world’s largest retailer, did not have success in its global expansion into the retail markets of Germany and South Korea.[1][2][3] Walmart entered Germany in 1988 and, after opening 88 stores, left in July 2006 with a $1 billion write-off.[4] There were multiple reasons for leaving including tough competition, loyal country patronage (local customers may have preferred to shop at familiar and German-owned retailers, like Metro), and cultural differences.[5] Shoppers in this country thought smiling and friendly female sales clerks were flirtatious and unacceptable.[6] Sam Walton’s morning cheer (W-A-L-M-A-R-T), long store hours, and often resistant labor unions also contributed to their eventual departure.[7][8][9]

Similarly, Walmart entered South Korea in 1988 and left in May 2006 after opening 16 stores. Although competition was tough, Walmart also failed to anticipate problems with applying U.S. standards to stores in South Korea, such as using store shelves that were too high for short South Korean female shoppers, and wrapping fish in clear cellophane, despite the custom in South Korea of always buying fresh fish, alive in fish tanks at retail.[10]

Carrefour, from France, the world’s second largest retailer, also had problems and left specific international markets including South Korea.[11][12] It left Thailand in 2010 after opening 31 stores and may leave Malaysia in the near future. In late 2009, Carrefour pulled out of Russia four months after opening two stores. The company justified the closing citing,“…the absence of sufficient organic growth prospects and acquisition opportunities in the short and medium term that would have allowed Carrefour to attain a position of leadership.” However, the company was also concerned about pending Russian legislation that would limit the share of retailers with annual sales of 1 billion Russian rubles (approximately $32.6 million U.S. dollars).[13]

Carrefour created the hypermarket (from French hypermarche) concept in 1962.[14][15][16][17] It represents a gigantic retail store, which combines a full-service supermarket with a department or discount store. The average size of Carrefour’s hypermarkets is 215,000 square feet. Some of the original units in France have 95 checkout stations, 2 floors, and oversized shopping carts that interlock onto escalators for consumers traveling between floors. Other global retailers, such as Tesco, also operate hypermarkets. Walmart has utilized this hypermarket concept in creating their Supercenter stores in U.S.[18][19][20]

Carrefour once opened a hypermarket in the United States (Philadelphia, Pennsylvania) in 1976. It used a format straight from France, with no adaption to the U.S. market. Soon after opening, it faced a labor union strike, along with consumer resistance that eventually drove them to leave the market. Carrefour’s huge hypermarkets are difficult to keep profitable in markets with increasing competition, where consumer shopping behavior may need to change, and when shoppers are very price-sensitive.

Asia Represents New Challenges

Another recent example of a global expansion that faltered is Best Buy, which closed 11 stores in China during the first quarter of 2011. Electronics such as PCs and laptops are typically sold in major Chinese electronic retail stores where each manufacturer has a counter with an employee working as a sales agent.[21] Stores with names like Gome and Suming are often crowded, dirty, and noisy, but offer low prices. Best Buy tried to bring its U.S.-concept stores to China, offering cleaner stores, wider aisles, and non-commissioned sales people who were knowledgeable across multiple brands. However, Best Buy’s China endeavor required Chinese shoppers to change their shopping and buying behavior and expectations when buying electronic goods. Furthermore, Chinese electronic store competition offered lower prices than Best Buy. Though all of the stores carrying their name are gone, Best Buy still maintains a presence in China after acquiring a chain of electronic retail stores called Jiangsu Five Star Appliance, keeping the local store name and format.

India, with a population of 1.1 billion people, poses the greatest challenge to large international retailers. The Indian government has refused to allow big retailers to enter their market.[22][23] The rationale is to protect the thousands of small mom-and-pop stores, which dominate the market and currently supply daily foodstuffs and other products to their local populations.[24] These local small stores build personal relationships with customers, often offering home delivery, easy credit, and gifts and discounts to loyal customers.[25] Indian regulations for foreign retailers are complicated. Big-box stores such as Walmart or Carrefour are only allowed to partner with Indian companies in the wholesale sector, rather than selling directly to customers.[26] However, single brand retailers like Levi Strauss that primarily sell one manufacturer’s product are allowed to sell directly to consumers, but they must also have a (local) joint-venture partner. Global retailers such as IKEA, Walmart, Carrefour, and others are standing by to see if the government may ease these restrictions and let large retailers enter the market.[27] Walmart has entered India through the back door by forming a joint venture with the largest Indian cell phone operator, Bharti Enterprises. The Walmart store name cannot be seen in India; the joint venture store is called Best Price Modern Wholesale.[28][29]

Another U.S. retailer, Starbucks, has found a way to enter India. Starbucks recently formed a joint venture with India-based Tata Group to help them enter India by sourcing and buying coffee with Tata’s Coffee Division, which owns and operates coffee plantations.[30] Coffee has more popularity in Southern India but has gained a broader acceptance across the country in the past decade. New coffee chains appeal to young Indians who have more disposable income than their parents did when they were young. Along with being one of the fastest growing countries, India is also one of the youngest with about one-half of the population under 25 years old. Additionally, The Tata Group is allowing Starbuck’s to set up retail stores in their very upscale Taj hotels.

Global Expansion in the U.S. is Neither Fresh nor Easy

Tesco, the U.K. grocery chain and third largest retailer in the world, entered the United States with a healthier convenience store chain called Fresh & Easy. They studied the market for one year, sending more than 50 U.K. executives to live with California families, and then only opened stores in the West coast in California, Nevada, and Arizona.  Unfortunately, Tesco opened these stores in 2007, just before the recent financial crisis, and in general, sales have been disappointing.[31][32][33][34] Even with their extensive market research, they may not have obtained all there is to know about the U.S. food retail market. They did not hire a U.S. country manager or partner with an existing U.S. retailer or company that could offer insight into the very competitive U.S. market. Tesco’s initial long-term goal was to open 1,000 Fresh & Easy stores in the U.S. However, three years after opening their first store, they still only have 175 stores. The company lost $300 million in their most recent fiscal year ending February 26, 2011. A number of initial judgment errors may also have contributed to Tesco’s disappointing debut in the U.S. market including:[35]

1. Offering fresh fruit and vegetables pre-wrapped in plastic, where U.S. shoppers generally prefer to select these items individually.[36]
2. Selecting a number of the store sites that were retrofits, where previous supermarkets or food stores failed.
3. Selecting some store sites that were located on the wrong side of the street, more accessible to inbound rather than outbound commuters who would be more likely to be thinking about what to buy for dinner.
4. Selecting stores located in geographic areas with the highest rates of (real estate) foreclosures in the nation.
5. Initially not accepting manufacturer cents off coupons.[37]
6. Initially designing stores with concrete floors and a “stark” look.
7. Using private-label, Fresh & Easy-branded products for about 50 percent of the products offered, where U.S. shoppers prefer recognizable and better known brand names.[38]

After initial store sales slowed, Tesco executives halted expansion plans, and made adjustments to the merchandise mix, accepted store coupons, and expanded store hours.[39] It seems Tesco’s original rollout plan may have been too ambitious.[40] The decision to continue expansion or pull-out of the United States has been postponed until 2013. Tesco has the resources to continue, but whether they will adapt and use innovative approaches necessary to maximize consumer acceptance and meet their financial goals remains to be seen.

Success Stories

McDonald’s and YUM! Brands’ stores can claim major success stories in far away places. McDonald’s does their homework before entering a market. For example, India is the only country in the world where they do not serve beef hamburgers.[41] They determined over 80 percent of the Indian population is Hindu, who believe the cow is sacred and would be offended if offered as an eating choice. Hindus respect and honor cows because they are the main animal that provides for their family. They can make many different foods (from a live cow) such as milk and yogurt and can use the milk for other Indian foods. Cows can also be used for transportation and farming. Therefore, the McDonald’s menu in India consists of many vegetarian dishes with names such as: McVeggie Sandwich, McAloo Tikki, Paneer Salsa Wrap, and Pizza McPuff. They also offer some traditional items found in the U.S. such as Filet-O-Fish, but a variety of country-specific chicken dishes such as: McChicken on a bun, Chicken McGrill and McCurry Pan.[42]

YUM! Brands, which owns KFC, Pizza Hut, and Taco Bell, has been a phenomenal success in China.[43][44][45] The country alone accounted for 54 percent of YUM!’s overall $264 million profit during the first quarter of 2011.[46] KFC had a first-mover advantage, entering China in 1987, followed by Pizza Hut in 1990.[47] Their international restaurants are different from their stores in the U.S. For example, Pizza Hut offers an expanded Italian menu. is closer to a family/fine-dining restaurant, and caters to Chinese eating tastes with seafood and shrimp pizzas. In both India and China, patrons can order beer or wine with their meals.[48] KFC has adapted offerings to appeal to the tastes of the Chinese family including a breakfast menu. It features Chinese staples such as youtiado (a donut on a stick) and bowls of Chinese congee.[49] In 2010, KFC China introduced rice to the menu for the first time.[50] They even added hamburgers and french fries, which are not offered in the United States.

YUM! now has approximately 3,665 restaurants in China, and is growing.[51] The company has intentionally not launched Taco Bell in China, knowing Mexican-type food may be a challenge in China. According to their 2010 annual report, YUM! has created their own quick-service restaurant chain in China called East Dawning, which is tailored to the local favorite cooking styles. They also own 27 percent of Little Sheep, the leading brand in the “hot pot” category, which has about 500 units and is the largest casual dining category in China.[52]

Zara also exemplifies a global retailer success story. A division of Spanish parent Inditex SA, Zara operates more than 1,500 stores in 81 countries. Zara generated annual sales revenue of 7.1 billion Euros in 2009 (approximately $9.6 billion U.S. dollars). Zara offers high-quality fashions at reasonable prices. Zara’s management resisted an industry trend of manufacturing in low-cost countries. Instead, most of its manufacturing is completed in Europe. They never use advertising to promote their stores. Their unique ability to dispatch designs twice a week to their stores has won a loyal following. Zara has been described by Louis Vuitton Fashion Director Daniel Piette as “possibly the most innovative and devastating retailer in the world.”[53]

Zara’s success has been innovation, vertical integration, and consumer centricity.[54] Their Spanish headquarters responds quickly to local tastes and trends and depends on their store staff as lookouts for trends that enable Zara to quickly design, produce, and deliver fashion items in limited quantities to markets that want them. An item seen one week may not be in that store the next week whether sold or not. Their in-store design and range of fashionable and affordable merchandise has been a hit around the world.

Lessons Learned

Based on the various retail companies discussed, and their global expansion efforts of varying effectiveness, below are some key takeaway points:

1. Do your homework carefully before entering a new international market.
2. Study the buying behaviors in the market. This includes shopping and buyer behavior, consumer attitudes, expectations, and price sensitivity.
3. Recruit someone familiar with the local culture, not a transplant from a successful store chain thousands of miles away. Tesco’s Fresh & Easy initially hired British expatriates instead of hiring locally.[55]
4. Get the merchandise mix correct, or at least identify what not to offer. Walmart offered golf clubs in Brazil where that sport was not popular. They also initially sold ice skates in Mexico where there are no ice skating rinks.[56]
5. Adapt and be willing to make changes to local market preferences. Pizza Hut in China offers a full Italian-based menu.
6. Atmospherics may be more important in some developed countries than in others.
7. Identify growing trends in targeted countries and appeal to those trends.
8. Consider a paradigm change on how to enter the market, such as Starbucks in India.[57]
9. Be willing to adopt a different retail brand name if needed to attract customers. Walmart learned this lesson as they expanded globally by not always using or needing the Walmart brand name. Walmart operates in the U.K. under the ASDA and George brand names.[58]
10. Non-traditional merchandising may be needed to accommodate and attract international shoppers to gain their loyalty. Coupons may not work in parts of Asia but selling live seafood does.

Conclusion

Taking a proven retail model and exporting it to a new country, often with a new set of competitors, a different language and culture, and unique shopper expectations, requires more than just market research before entry. International expansion is a common next step for large retailers having achieved success at home. Retailers that seek future international growth need to avoid repeating prior mistakes from others who came before them. Even the most successful and largest global retailers have encountered unanticipated problems in global markets that could have been identified and prevented prior to their launch.

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[1]Boyle, Matthew. “Wal-Mart vs. the World.” CNNMoney.com. December 19, 2005. http://money.cnn.com/2005/12/19/news/fortune500/walmart_fortune_1219/.

[2]Olsen, Kelly. “Wal-Mart Pulls out of South Korea, Sells 16 Stores.” USA Today, May 22, 2006. http://www.usatoday.com/money/industries/retail/2006-05-22-walmart-korea_x.htm.

[3]Butler, Sarah, and Tom Bawden. “Wal-Mart-Pulls out of Germany at Cost of $1bn.” The Times (London, England), July 29, 2006.

[4]Landler, Mark, and Michael Barbaro. “Wal-Mart’s Overseas Push Can Be Lost in Translation.” The New York Times/International Herald Tribune, August 2, 2006. http://www.nytimes.com/2006/08/02/business/worldbusiness/02iht-walmart.2363495.html?pagewanted=all.

[5]Datamonitor Research. “Premium Company Profile: Metro AG,” February 2008.

[6]Landler and Barbaro, loc. cit.

[7]Ibid.

[8]Butler and Bawden, loc. cit.

[9]Naughton, Keith. “The Great Wal-Mart Of China.” Newsweek Magazine, October 29, 2006. http://www.thedailybeast.com/newsweek/2006/10/29/the-great-wal-mart-of-china.html.

[10]Ibid.

[11]“Company Profile for CARREFOUR.” Yahoo! Finance. August 2, 2009.

[12]Supermarket News. “SN’s Top 25 Worldwide Food Retailers for 2009.” http://supermarketnews.com/profiles/top25-2009/top-25/.

[13]Barinova, Alla. “Carrefour Pulls out of Russia After Just Four Months.” Bord Bia – Irish Food Board. Accessed October 30, 2009. http://www.bordbia.ie/industryservices/information/alerts/Pages/CarrefourpullsoutofRussia.aspx?year=2009.

[14]2009 Annual Activity and Sustainability Report. Report. Carrefour Group, 2009. http://www.carrefour.com/docroot/groupe/C4com/Pieces_jointes/RA/RA_Carrefour_PDF_WEB_2009VE.pdf.

[15]The Customer at Heart: 2008 Annual Report. Report. Group Carrefour, 2008. http://www.carrefour.com/docroot/groupe/C4com/Finance/Publications_et_presentations/Les%20rapports%20annuels/CARREFOUR_RA_2009_UK_01-56_V2.pdf.

[16]Supermarket News, loc. cit.

[17]“Carrefour with New Hypermarket Concept.” News release, September 20, 2010. Retail Digital. http://www.retail-digital.com/sectors/carrefour-new-hypermarket-concept.

[18]Carrefour Group, 2009, loc cit.

[19]Group Carrefour, 2008, loc cit.

[20]Rohwedder, Cecilie, “A New Chief Seeks to Make French Retailing Giant Nimbler,” The Wall Street Journal, November 30, 2006.

[21]“Changes Are in Store for China’s Electronics Retailers: Which Model Will Win?” Knowledge@Wharton-China. May 13, 2009. http://www.knowledgeatwharton.com.cn/index.cfm?fa=viewArticle&articleID=2038&languageid=1.

[22]Srivastava, Mehul. “Big Retailers Still Struggle in India.” Businessweek, October 16, 2009. http://www.businessweek.com/globalbiz/content/oct2009/gb20091016_385819.htm.

[23]Bajaj, Vikas. “A Starbuck’s Venture in Tea-Drinking,” The New York Times, January 13, 2011.

[24]Singh, Madhur. “A Backlash for Big Retail in India.” TIME.com, October 17, 2007. http://www.time.com/time/business/article/0,8599,1672425,00.html.

[25]Srivastava, Mehul. loc cit.

[26]“Wal-Mart India’s Raj Jain: The Biggest Challenge Is There Is No Organized Supply Chain.” India Knowledge@Wharton. July 10, 2008. http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4305.

[27]Singh, Madhur. loc cit.

[28]Bellman, Eric, and Kris Hudson. “Wal-Mart to Enter India in Venture.” The Wall Street Journal, November 28, 2006, A3 sec.

[29]India Knowledge@Wharton. July 10, 2008, loc cit.

[30]Bajaj, Vikas, loc cit.

[31]Sonne, Paul. “Tesco Unfolds Map for Global Expansion.” MarketWatch – The Wall Street Journal. June 9, 2009. http://www.marketwatch.com/story/tesco-unfolds-map-for-global-expansion-2010-06-08.

[32]Silverthorne, Sean. Tesco’s Stumble into the U.S. Market. Harvard Business School. Case Study. October 25, 2010.

[33]Gordon, Kathy. “Not So Fresh & Easy for Tesco in the U.S.” The Wall Street Journal, January 12, 2010, The Source sec. http://blogs.wsj.com/source/2010/01/12/not-so-fresh-easy-for-tesco-in-the-us/.

[34]Baertlein, Lisa. “Tesco’s Fresh & Easy Evolving in Tough U.S. Market.” Reuters.com, May 20, 2009. http://www.reuters.com/article/2009/05/20/us-tesco-idUSTRE54J44S20090520.

[35]Silverthorne, Sean, loc. cit.

[36]Gunthrie, Jonathan. “Case Strengthens for Tesco to ditch Fresh & Easy,” FT.com, April 19, 2011.

[37]Silverthorne, Sean, loc. cit.

[38]Ibid.

[39]Ibid.

[40]Baertlein, Lisa, loc cit.

[41]Livermore, Rebecca. “McDonald’s India: Where’s the Beef,” Travel, January 8, 2008.

[42]Ibid.

[43]“Yum! Brands (US) Builds on International Success.” WFA – World Franchise Associates, October 7, 2010. http://www.worldfranchiseassociates.com/franchise-news-article.php?nid=656.

[44]La Monica, Paul R. “Colonel Sanders: China’s Favorite Import.” CNNMoney.com. January 19, 2011. http://money.cnn.com/2011/01/19/news/companies/thebuzz/index.htm.

[45]“Yum! Brands 2010 Annual Customer Mania Report.” Yum! Brands. 2010. http://www.yum.com/annualreport/.

[46]Burchett, Andrew. “Yum! Brands Set To Dominate The Global Fast Food Market.” Elite Inside Trader. May 10, 2011. http://eliteinsidetrader.com/2011/05/10/yum-brands-set-to-dominate-the-global-fast-food-market/.

[47]Ibid.

[48]Ibid.

[49]Ibid.

[50]Ibid.

[51]La Monica, Paul R. loc. cit.

[52]Yum! Brands. 2010, loc. cit.

[53]“Zara.” Wikipedia. 2010.

[54]Hume, Marion, “The Secrets of Zara’s Success,” The Telegraph, June 22, 2011.

[55]Naughton, Keith. loc cit.

[56]Landler and Barbaro, loc cit.

[57]Bajaj, Vikas. loc cit.

[58]Landler and Barbaro, loc cit.

Additional Resources:

Lague, David. “Unions Triumphant at Wal-Mart in China.” International Herald Tribune – The New York Times, October 12, 2006. http://www.nytimes.com/2006/10/12/business/worldbusiness/12iht-unions.3134329.html?scp=2.

Saltmarsh, Matthew. “Carrefour Chief Pursues Strategy to Strengthen Home Market.” The New York Times, June 3, 2010. http://www.nytimes.com/2010/06/04/business/global/04retail.html.

“Wal-Mart 2009 Annual Report – Now More Than Ever.” Walmartstores.com. 2009. http://walmartstores.com/sites/AnnualReport/2009/.

“Walmart Annual Report 2010.” Walmartstores.com. 2010. http://walmartstores.com/sites/annualreport/2010/.

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2006 Volume 9 Issue 2

• Business Survival Skills
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• HR’s Strategic Partnership with Line Management
• The Book Corner
• Obesity, Social Responsibility, and Economic Value
• Graziadio Faculty Discuss Ethics

2006 Volume 9 Issue 1

• A Winning Tool to Manage Price: The Pricing Checklist
• Update: The Price of Oil
• Mapping IT Resources for Successful Implementations
• Is the Real Estate Market a House of Cards?
• Whither Now Dow?
• The Book Corner

2005 Volume 8 Issue 4

• Whistleblowers
• Editorial: Does a Non-Public Business Need SOX?
• IT Matters
• A New Imperative for Management: Sexual Harassment Training
• The Company Director’s Role In Company Growth
• Editor’s Note
• The Book Corner
• Fair Trade or Strategic Concern: The Unocal War

2005 Volume 8 Issue 3

• The IT Governance Road Map
• Avoiding Ethical Misconduct Disasters
• The Positive Psychology Approach to Goal Management
• Antitrust Law in the European Union
• Editor’s Note
• The Book Corner
• D & O Policies: Greater Risks Less Coverage
• A Blueprint for Change: Appreciative Inquiry

2005 Volume 8 Issue 2

• Connecting Enterprise Information and People in a Web World
• The Leader’s Role in Strategy
• The Practical Nuances of Leadership
• Editor’s Note
• Corruption Across Borders
• Resolving Intra-Organization Conflicts
• An Uphill Battle
• Leading and Managing Change
• The Book Corner

2005 Volume 8 Issue 1

• The Link Between Price and Profit Margin in a Global Market
• IT MATTERS
• The Impact of Empowered Employees on Corporate Value
• What You Need to Know about Attorneys’ Fees
• Editor’s Note – Phishing
• The Book Corner
• Strengthening Value-Centered Ethics (Part 3)
• Will Your Company’s Electronic Records Storage Withstand Legal Scrutiny? – Graziadio Business Review
• Conversation on Leadership with Jeff Shell

2004 Volume 7 Issue 3

• Litigate or Arbitrate?
• Presidential Elections and Stock Market Cycles
• Businesspersons Beware: Lying is a Crime
• Strengthening Value-Centered Ethics (Part 2)
• Attempting to Control Health Care Costs – Again
• Editor’s Note
• The Crude Facts About the Price of Oil
• Conversation with Stephen Baum
• The Book Corner
• The Uncertain World of Trademark Dilution

2004 Volume 7 Issue 2

• Does Corporate Social Responsibility Pay Off
• Strengthening Values Centered Leadership
• The Twin Deficits
• GBR Conversation with Robert Miller
• The Book Corner
• From Michelangelo to the Modern Boardroom
• Preparing for a Future Labor Shortage

2004 Volume 7 Issue 1

• Slowing Runaway Juries
• Merger and Acquisition Strategies
• Slips, Trips, and Falls
• Using Conflict to Your Advantage
• Wired
• Editorial – Don’t Panic!
• Seek and You Might Find
• GBR Conversation with Tom Ross
• The Dollar vs. the Euro
• The Book Corner

2003 Volume 6 Issue 4

• Negotiating Effectively
• Why Good Leaders Do Bad Things
• Editorial: Cybersatire
• Main Street and Hedging
• E-Business at the Graziadio Business Review
• What Stays and Who Pays?
• Inflation to Deflation and Back?
• Conversation with Betsy Bernard
• The Car Deal
• The Book Corner
• Using Dashboard Based Business Intelligence Systems

2003 Volume 6 Issue 3

• The Cost of Lost Data
• Consolidate All IT?
• Blowing the Whistle
• Creating and Sustaining an Ethical Workplace Culture
• Editorial – Onward and Upward?
• IT Matters: Portal Combat
• Facing Up to the Possibility of Deflation
• Dialogue With Four Executives

2003 Volume 6 Issue 2

• Hedging Strategies for Uncertain Times
• Do Not Call!*
• Improving R and D Performance Teamwork trumps solo endeavors
• Just-in-Time to Just-in-Case
• Increasing the Firm’s Strategic IQ
• Special Purpose Entities
• Shock and Awe
• IT Matters: Webhosting
• Conversation with Bert Boeckmann

2003 Volume 6 Issue 1

• Communicating Your Strategy
• Reforming Corporate America
• Recognize the True Cost of Compensation
• Learn from Experience
• Use Emotional Intelligence to Cope in Tough Times
• Conversation with Lacy Edwards of Evoke Software
• Editorial
• Predicting Bankruptcy in the WorldCom Age

2002 Volume 5 Issue 4

• Build Value in a Small Business
• Protect Your Trade Secrets
• Managing in an Era of Multiple Cultures
• Pros and Cons of Expensing Stock Options
• IT Matters: Web Services May Bridge the Great Culture Gap
• Editor’s Note
• Conversation with Paul Orfalea
• Calculating the Strategic Value of Customer Satisfaction

2002 Volume 5 Issue 3

• Encourage Your Employees to Play
• Managerial Leadership at Twelve O’Clock
• Remembering George L. Graziadio
• Editor’s Note: Bad Boys in the Board Room
• Who’s Driving American Firms?
• Supreme Court Sides With Business
• Using Asset Allocation Strategies to Recover from a Bear Hug
• Mediate, Arbitrate or Litigate?
• IT MATTERS: The Wonderful World of the Wireless Web

2002 Volume 5 Issue 2

• Will China Float the Yuan?
• Does Market Efficiency Trump Behavioral Bias in Finance Decisions?
• Making Mergers a Growth Strategy
• Sealing Cracks in the Capital Markets
• Artificial Intelligence Techniques Enhance Business Forecasts
• Editor’s Note: Weapons of Mass Disruption
• E-Commerce Reboots
• IT MATTERS: Web Services Prevail Despite Travail
• Go Directly to Jail?
• GBR CONVERSATION With John Shields

2002 Volume 5 Issue 1

• Build a Culture of Value Creation
• Choose Tomorrow’s Leaders Today
• Small Firms Keep R&D Vibrant
• Teams Use IT to Manage Client Impressions
• Putting Spirituality to Work
• IT MATTERS: Fifty Years and Counting
• Defining Disability Under the ADA
• GBR Conversation With Joe Rokus
• Editor’s Note: Decisions, Decisions, Decisions

2001 Volume 4 Issue 4

• Gender Impacts Virtual Work Teams
• Doing Business in a Volatile World
• The Strategic Downside of Downsizing
• Editor’s Note: Corporate Citizenship in the Wake of September 11!
• The Economic Downturn is No Surprise
• IT MATTERS: ROI for Tech Deployments in the Downturn
• Supreme Court Faces Key Business Cases
• GBR Conversation with Michael Josephson
• Are Workplace Bullies Sabotaging Your Ability to Compete?

2001 Volume 4 Issue 3

• Suddenly Unemployed?
• Too Late for an IPO?
• Electricity Price Gouging in California?
• Editor’s Note: Surf’s Up!
• The Fine Art of Delegation
• Waiting Games People Play
• Business at the Bar
• GBR Conversation with Senator Sandra Bowen

2001 Volume 4 Issue 2

• Knowledge Management and Business Portals
• Trust as a Competitive Advantage
• Is Price Everything?
• Editor’s Note: A Quarter Without Quarter
• Has the Dow Really Escaped the Bear?
• Dot.Gone
• IT MATTERS: E-Business is Definitely an E-Ticket Ride!
• Downsizing with Dignity
• GBR Conversation Mitchell J. Held
• The California Electricity Crisis

2001 Volume 4 Issue 1

• Repetition Leads To Innovation
• What’s the Problem?
• Editor’s Note: Quakes, Flakes, and Double Takes
• IT MATTERS: CRM Solution Seekers Beware!!!!
• Language, Culture and Global Business
• GBR Conversation Dr. Clyde Oden Jr.
• Personality Traits and Workplace Culture
• Who Wants to Lose a Million?
• The Power of Performance Profiling

2000 Volume 3 Issue 4

• Building Wealth
• How Small Firms Plan to Grow
• Using Internet Portals to Manage the Information Deluge
• Editor’s Note: Messy Brains and Global Opportunities
• SEC Requires Fair Disclosure
• IT MATTERS: MP3.com Completes Settlements
• GBR Conversation with Boyd Clarke
• Planning in a Complex World
• Business Be Advised!

2000 Volume 3 Issue 3

• Do Japan’s High Tech Failures Open Doors for Western Firms?
• Managing Earnings … or Cooking the Books?
• The Battle Over Merger Accounting – Graziadio Business Review
• GBR Conversation with senior economist
• Editor’s Note: Friends, Romans & Countrymen…
• What Directors Need to Know
• Still Thinking of Doing an IPO?

2000 Volume 3 Issue 2

• Managing Innovation through Corporate Venturing
• The Death of the Sales Force
• Thinking of Doing an IPO?
• Serving Each Other on the Inside
• Editor’s Note: Screaming Into the Future!
• GBR Conversation with Stephen J. Goldman
• Will Marketers Survive the Information Age?

2000 Volume 3 Issue 1

• Re-Assessing the Health of the Asian Tigers
• Knowledge Management and the Internet
• The Learning Organization in Practice
• Economic Forecasting
• Editor’s Note: A Short Hello!
• Are You Ready for E-Commerce?
• E-Business: The New Management Challenge
• GBR Conversation with Raytheon’s Daniel Burhnam
• The Bull Market’s Flawed Foundation

1999 Volume 2 Issue 4

• The Electric Day Trader and Ruin
• Teambuilding for Competitive Advantage
• Parable of the Commons
• Preserve and Strengthen a Business Partnership
• Editor’s Note: Here to Be Thrilled!
• GBR Conversation with Mike Roberts
• Telecommuting… Out of Sight, Out of Mind?
• Balancing Act for Employers in Today’s Labor Market
• Editor’s Note: Too Much Fun!

1999 Volume 2 Issue 3

• How Gerber Used a Decision Tree in Strategic Decision-Making
• Customer Satisfaction Measurement
• Get Your Message Across!
• E-Commerce & Taxation
• GBR Conversation with Dr. Gary Hamel
• To Join or Not To Join..?
• T.I.P.S.

1999 Volume 2 Issue 2

• Defamation Vs. Negligent Referral
• Maximize Business Achievement
• Preserving Family & Business Assets – Graziadio Business Review
• Knowledge is Power…
• Editor’s Note: Welcome to the Graziadio Business Review
• E-Commerce & Taxation
• GBR Conversation with Wayne “Buz” Knyal
• Cultivating the Customer Asset
• Decision-Making in a Global Environment

1999 Volume 2 Issue 1

• Business and Universities Moving to Collaborative Technologies
• Tips for Reducing Executive Stress
• Russia at the Crossroads
• Editor’s Note: Volume I, Issue 4
• GBR Case Study
• Launching an Effective Citizen Advisory Panel

1998 Volume 1 Issue 3

• Retirement Call to Action
• The European Directive On Data Privacy
• Editor’s Note: Welcome to the GBR, Volume I, Issue 3
• Debt Tied to Lower Firm Performance
• A conversation with Angelo Mozilo
• Boosting Country Club Memberships With Innovative Marketing and Pricing Concepts

1998 Volume 1 Issue 2

• Management Skills for the 21st Century
• Middlaning
• Editor’s Note: Welcome to the GBR, Volume I, Issue 2
• A conversation with Jeffrey Rigsby
• Cultural Insights on Doing Business in China
• When Worlds Collide

1998 Volume 1 Issue 1

• Editor’s Note: Welcome to the GBR
• Guide to Personal Investment Software
• Southeast Asia: Crisis To Recovery
• Growth Strategies for High Tech Firms
• A conversation with George L. Graziadio
• The Human Realities of Corporate Downsizing
• AB Corporation Case Study

Leveraging Action Learning as a Talent Management Strategy during Economic Uncertainty

The current economic landscape affords companies the opportunity to fully develop leadership talent against a backdrop of genuine challenge and tangible uncertainty—attributes integral to an effective action-learning program.

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While there are legitimate concerns with regard to making workforce investments during periods of economic uncertainty, the business case for doing so is unmistakable. What’s more, such periods may actually provide the best opportunity to incorporate action learning as an essential component of an organization’s broader talent management strategy. Action learning is a method for developing leadership talent through team projects that task high-potential employees with addressing organization-level problems or challenges. Talent management can be defined as the integrated system of strategies, policies, and programs designed to identify, develop, deploy, and retain talent to achieve strategic objectives and meet future business needs.[1] The current economic landscape affords companies the opportunity to fully develop leadership talent against a backdrop of genuine challenge and tangible uncertainty—attributes integral to an effective action-learning program. This article seeks to marry the business case for investment in talent management with practical suggestions for implementing an action-learning initiative for businesses and organization development practitioners seeking to leverage the current economic environment for leadership development opportunities. In addition, it fills an important gap in the current action-learning research literature by synthesizing the most relevant case studies, review articles, and empirical studies into a unified framework that is geared toward practitioners.

Action Learning in the Broader Talent Management Strategy

Talent management in exemplary organizations can be understood as a series of phases, with action learning occupying a specific role within its relevant phase. A high-performance talent-management system can be thought of as a series of six phases set in the context of a cyclical model.[2] These phases are as follows:

1. Establish the Business Case for Talent Management
2. Define High-Potential Leaders
3. Identify High-Potential Leaders
4. Communicate High-Potential Designations
5. Develop High-Potential Leaders
6. Evaluate and Reinforcing the Talent-Management System

Exploring each phase in detail is beyond the scope of this article; however, recognition of such provides context for further discussion of action learning. Action learning is a central part of the fifth phase, with an emphasis on leadership development through projects that task high-potential employees with addressing organization-level problems or challenges. Such project-based experiences provide high potentials with broader exposure, forcing individuals to shed silo views of the organization in favor of an enterprise-wide perspective. Consequently, and as augmented by its inherently experiential nature, action learning promotes the development of a systems view of the organization.

Program Design: A Generic Model

As organization development practitioners often attest, research findings and industry best practices on action learning are strewn across published and unpublished case studies, review articles, empirical papers, and technical reports. Fortunately, however, all forms of action learning share similar attributes: “Real people taking action on real problems in real time, and learning while doing so.”[3]

An action-learning initiative should be tailored to fit its specific circumstances. The job of an action-learning program architect, most often a human resource or organizational development practitioner, is to create the conditions for learning to take place.[4] Action-learning best practices suggest that six main considerations should guide the program’s design and implementation: Advocacy, Problem, Group, Facilitator, Learning, and Action. To illustrate each of these design and implementation considerations, we describe an exemplary action-learning initiative at the Boeing Company. Boeing’s Global Leadership Program debuted in 1999 as a significant investment designed to help Boeing maintain a leadership position in the global aerospace industry and enhance the company’s leadership bench strength.[5] The program had five key goals for its global executive participants:[6] 1) Practice working together as one global company; 2) Value and seek understanding of the history, culture, politics, and customs of countries/regions; 3) Appraise the business practices, issues, and competitive dynamics within a country/region; 4) Assess business opportunities in a prospective country/region; and 5) Understand the opportunities for international joint ventures and partnerships.

Advocacy

First, and most importantly, action-learning programs must be sanctioned by organizational sponsors who are committed to remaining fully engaged in the process. The involvement of high-level internal stakeholders (i.e., C-level executives) is important for two reasons: First, it communicates the importance of the project as an investment. Second, for senior management, it brings the institutional perspective into the program and the program perspective back to the C-suite.[7] In Boeing’s program, the executive board selected both the business issues and strategic countries for the project focus[8], and remained involved through the entire cycle. From there, each project culminated in a presentation before the executive committee at a regularly scheduled session.[9]

By facilitating this reciprocal connection, participants can benefit from a broader view of the project’s role, and management can more easily justify the cost in terms of money and time.[10] Failure in this area may render the program impotent and pretentious, as the projects are likely to be more artificial.[11] Action-learning program participants will take both the program and their contribution to it more seriously if high-level support is visible.

Problem

With the requisite advocacy in place, the scope of the action-learning program can take shape. Foundationally, this includes the problem that the participants will work to resolve. To legitimize the program, the featured problem should represent an important current challenge or opportunity specific to the overall organization and relevant to the group.[12] The goal is to challenge participants to break free of any silo views forged in their respective functions, departments, or divisions, and to assume a macro-organizational perspective. Accordingly, the problem should be significant, such as a key problem facing the company as a whole.[13] It should be a problem with no known solution, and therefore, the group’s responsibility to solve.[14] This way, the action-learning program allows the organization to benefit from adversity. By carefully framing significant macro-organizational challenges as opportunities for employees to develop their leadership skills, the organization can effectively leverage its adversity to develop leadership capacity.[15] In Boeing’s Global Leadership Program, facilitators carefully assigned each action-learning participant to a country and business issue that was strategically and holistically relevant to the company.[16]

Group

Action learning is conducted in small, stable groups, the composition of which represents an important consideration for program architects.[17] Recommendations vary as to the ideal group size, but suggestions range from four to eight participants.[18] Boeing’s action-learning teams were comprised of a small number of senior executives—directors, division directors, and vice-presidents.

Regardless of group size, a successful program starts with individuals who are engaged, exhibiting independent readiness to learn from experience.[19] Best practices should be employed in identifying such individuals, and in fostering a truly comprehensive assessment of leadership talent. Best practice systems define high-potential leaders according to a three-dimensional model comprised of a (1) core set of leadership competencies, (2) the candidate’s motivation to advance, and (3) an assessment of the candidate’s readiness for advancement.[20] Ultimately, groups are composed of individuals from across functions, departments, organizations, and professions,[21] and have been selected by managerial personnel fully engaged in the identification process.[22] Accordingly, at Boeing, individual business units facilitated nominations.[23]

Facilitator

While the group members focus on the problem, a facilitator focuses on assuring that group members reflect on the problem-solving process and strategy-development experience so that learning is captured and capacity is developed.[24] The facilitator is most likely a human resources or organizational development professional who is internal or external to the organization. Facilitators do not teach, because they do not have the answer. Rather, they focus on the learning process, and its application to practice.[25] At Boeing, facilitators intercede at various points in the program to help participants reflect on possible team capability improvements and opportunities to transfer learning to other aspects of company operations.[26]

The facilitator’s initial role is to assist in team cohesion by helping group members share leadership duties and understand their strengths and weaknesses.[27] He or she acts as the group’s consciousness regarding how members listen, understand the problem, provide each other with feedback, and make assumptions.[28] They must let participants learn independently and from each other. They also help group members collaboratively reflect while ‘in’ action, rather than just reflecting ‘on’ it later.[29]

Learning

As noted, action-learning programs emphasize ‘learning by doing’ by casting participants in problem-solving roles.[30] Accordingly, they are vastly different from traditional training methods because action-learning programs are inherently committed to questioning the most fundamental assumptions underlying organizational thought processes.[31] As a result, the approach is “elicitive” and generates relevant information via purposeful reflection instead of disseminating what a trainer has deemed appropriate.[32]

Action learning’s focus is on asking the right questions rather than focusing on the right answers, fostering a process of first questioning to clarify the exact nature of the problem.[33] These questions may take the form of interview protocols, surveys, and/or other methods developed by the program participants and should be designed to collect information from relevant organizational divisions or business units. Once the information is collected, participants then work to identify possible solutions or rephrase new questions through reflection. At various points in Boeing’s Global Leadership Program, facilitators encouraged intentional reflection with the express purpose of identifying learning, and possible ways to employ that learning to improve team capabilities and other company operations.[34]

Learning results from the questioning process via an arbitrage of programmed knowledge (i.e., book knowledge), questioning (i.e., fresh insight), and reflection (i.e., deconstruction). This kind of learning builds organizational capacity, and is the salient goal of any action-learning program. Thus, “action learning shows its strength not in finding the answers to questions that have already been posed (the role of experts) but in finding the questions that need to be answered (the role of leaders).”[35]

Action

This final piece—a commitment to acting on the action-learning group’s recommendations, or giving it the power to take action—fully legitimizes the program and its transformational potential.[36] As Revans noted, “responsible experience alone is the true motivator, the impartial witness and the final judge of meritorious learning.”[37] Accordingly, action-learning program participants must understand from the beginning that action will be the outcome. At Boeing, recommendations stemming from the program were implemented and a comprehensive evaluation process developed to measure the return realized both in terms of recommendation quality and learning transfer.

Reasons Action-learning Initiatives Fail

Failure to Reflect

“Successful organizations fail in many different ways, but they share one underlying cause: A failure to reflect.”[38] The same is true of action-learning programs. Action-learning programs should provide for frequent, regular reflection (i.e., daily, weekly, etc.), which forces participants to reflect more directly on immediate impressions, experiences, and specific circumstances.[39] Notably, attention should be directed to what is working—an appreciative inquiry approach that identifies the organization’s core strengths[40]—in addition to problem areas or opportunities. In practice, this may be an obligatory weekly session, which includes an individual journaling exercise and a related group presentation. Journaling will focus the participant’s attention on his/her own understanding; the presentation will enhance the participant’s ability to recognize the different operational, functional, and/or regional perspectives represented in the group. The combination will increase the candidate’s awareness of the interdependence among functional units.[41]

Limited Focus on Team Learning/Solutions

Generally, this mistake appears as a failure to develop strong norms around expression and/or appreciation of the group’s diverse perspectives.[42] It may manifest as a participant who is an ‘expert’ on the issue being addressed and, as a result, project recommendations become less insightful or creative, group members become less involved, and the learning experience becomes increasingly shallow.[43]To address this issue, individual participants should commit their thoughts to public scrutiny through oral or written presentations, as previously described.[44] The structured expression that results ensures individual contribution, a wider range of considerations, individual and team learning, and further reflection and conceptualization.[45]

Poor Follow Up on Project Outcomes

Project group members are often left out of the implementation of their plan, thus short-circuiting the transfer of their learning experience back into the workplace.[46] These pitfalls can be avoided by emphasizing substantive post-project opportunities for participants to continue their involvement with project recommendations.[47] These may consist of serving on task forces, heading committees, sharing project findings, or serving in newly crafted full-time positions for which a participant leaves his current post. If implementation involvement is not possible, participants should at a minimum be kept informed through debriefings staggered over the life of the initiative.[48] Careful attention should be paid to thoughtfully balancing the workloads and incentive plans for high-potential participants given the significant time and energy demanded by their formal job duties and their roles on action-learning teams.

The Business Case

The business case for investing in action-learning programs and other talent management practices despite the economic downturn is supported by compelling research evidence. The empirical research literature and industry best practices suggest that there are three primary data-driven rationales for continued investment in action-learning programs: business financial performance, employee productivity, and employee retention. A recent study analyzing publicly held firms representing major industries concluded that a one-standard-deviation improvement in talent management practices resulted in an $18,641 increase in market value per employee.[49][50] Other studies conclude that for every standard deviation of improvement, firm market value increases by 10 percent, or anywhere from $38,000 to $78,000 per employee.[51] Similar results have been observed regarding both employee performance and turnover. Huselid and colleagues’ award-winning research concluded that a one-standard-deviation improvement in talent management practices yielded $27,044 increase in sales per employee.[52][53] This represents nearly a 16 percent increase in the mean sales per employee ($171,099); and, assuming that these effects are sustained for a five-year period at an eight percent discount rate, the present value sales increase is an astounding $107,979 per employee.

While the upside of investing in action-learning programs is dramatic, the downside that results from failing to do so is even more compelling. Research in the healthcare industry concludes that turnover regularly costs healthcare organizations at least five percent of the total annual operating budget.[54] While employee turnover, particularly among high-potential employees, represents an enormous annual cost to organizations, consistent research findings indicate that talent-management practices and particularly action-learning initiatives are among the most effective means of retaining top talent.

Conclusion

The strong business case in support of workforce investment combined with the current difficult economic landscape offers organizations a compelling opportunity to leverage adversity by developing an action-learning initiative to complement current talent-management strategy. In so doing, six main considerations should guide the program’s design and implementation: Advocacy, Problem, Group, Facilitator, Learning, and Action. Developing an action-learning program in accordance with these insights will help practitioners ensure that common mistakes will not befall new programs.

---

[1] Silzer, Robert Frank., and Ben E. Dowell. “Strategic Talent Management Matters.” In Strategy-driven Talent Management: A Leadership Imperative, 3-72. San Francisco: Jossey-Bass, 2010.

[2] Groves, Kevin. “Talent Management Best Practices: How Exemplary Health Care Organizations Create Value in a down Economy.” Health Care Management Review 36, no. 3 (August/September 2011): 227-40.

[3] Waddill, D. D., and M. Marquardt. “Adult Learning Orientations and Action Learning.” Human Resource Development Review 2, no. 4 (2003): 406-29.

[4] Smith, P. A. C. “Action Learning and Reflective Practice in Project Environments That Are Related to Leadership Development.” Management Learning 32, no. 1 (2001): 31-48. doi:10.1177/1350507601321003.

[5] Marguardt, M. J. “Developing Global Leaders via Action Learning Programs: A Case Study at Boeing.” Thai Journal of Public Administration 3, no. 3 (2005): 133-57.

[6] Ibid.

[7] Liedtka, Jeanne M., Carol Weber, and Jack Weber. “Creating a Significant and Sustainable Executive Education Experience: A Case Study.” Journal of Managerial Psychology 14, no. 5 (1999): 404-20. doi:10.1108/02683949910277157.

[8] Marguardt,  loc. cit.

[9] 9 Ibid.

[10] Liedtka, loc. cit.

[11] Raelin, Joseph. “Does Action Learning Promote Collaborative Leadership?” Academy of Management Learning & Education 5, no. 2 (2006): 152-68.

[12] Conger, Jay, and Ginka Toegel. “Action Learning and Multi-rater Feedback as Leadership Development Interventions: Popular but Poorly Deployed.” Journal of Change Management 3, no. 4 (2001): 332-48. doi:10.1080/714023841.

[13] Ibid.

[14] Raelin, Joseph. “Does Action Learning Promote Collaborative Leadership?” Academy of Management Learning & Education 5, no. 2 (2006): 152-68.

[15] Orr, J. E., and K. Sack. Setting the Stage for Success: Building the Leadership Skills That Matter. Korn/Ferry International, 2009. PDF.

[16] Marguardt, loc. cit.

[17] Smith, Peter A.C., and Judy O’Neil. “A Review of Action Learning Literature 1994-2000: Part 1 – Bibliography and Comments.” Journal of Workplace Learning 15, no. 2 (2003): 63-69. doi:10.1108/13665620310464102.

[18] Waddill, D. D., and M. Marquardt. “Adult Learning Orientations and Action Learning.” Human Resource Development Review 2, no. 4 (2003): 406-29.

[19] Raelin, loc. cit.

[20] Groves, Talent management.

[21] Waddill and Marquardt, loc. cit.

[22] Groves, Kevin S. “Integrating Leadership Development and Succession Planning Best Practices.” Journal of Management Development 26.3 (2007): 239-60.

[23] Marguardt, loc. cit.

[24] Waddill and Marquardt, loc. cit.

[25] Ibid.

[26] Marguardt, loc. cit.

[27] Raelin, loc. cit.

[28] Waddill and Marquardt, loc. cit.

[29] Raelin, loc. cit.

[30] Conger and Toegel, loc. cit.

[31] Raelin, loc. cit.

[32] Smith, loc. cit.

[33] Waddill and Marquardt, loc. cit.

[34] Marguardt, loc. cit.

[35] Revans, R. W. (1980) Action Learning, Blond & Briggs, London.

[36] Raelin, loc cit.

[37] Revans, R. The Golden Jubilee of Action Learning. Manchester, UK: Manchester Action Learning Exchange, 1988.

[38] Hammer, M., and S. A. Stanton. “The Power of Reflection.” Fortune, November 24, 1997. http://money.cnn.com/magazines/fortune/fortune_archive/1997/11/24/234339/index.htm.

[39] Conger and Toegel, loc. cit.

[40] Dick, B. “Action Research Literature 2006-2008: Themes and Trends.” Action Research 7, no. 4 (December 2009): 423-41.

[41] Groves, Talent management.

[42] Raelin, loc. cit.

[43] Conger and Toegel, loc. cit.

[44] Zuber-Skerritt, Ortrun. “A Model for Designing Action Learning and Action Research Programs.” The Learning Organization 9, no. 4 (2002): 143-49. doi:10.1108/09696470210428868.

[45] Conger and Toegel, loc. cit.

[46] Ibid

[47] Groves, Talent management.

[48] Conger and Toegel, loc. cit.

[49] Becker, Brian E., Mark A. Huselid, and Richard W. Beatty. The Differentiated Workforce: Transforming Talent into Strategic Impact. Boston, MA: Harvard Business Press, 2009.

[50] Huselid, M. “The Impact of Human Resource Management Practices on Turnover, Productivity, and Corporate Financial Performance.” Academy of Management Journal 38 (1995): 635-72.

[51] Becker, B. E., and Mark A. Huselid. “High Performance Work Systems and Firm Performance: A Synthesis of Research and Managerial Implications.” Research in Personnel and Human Resources Journal 16, no. 1 (1998): 53-101. http://www.markhuselid.com/pdfs/articles/1998_Research_in_PHRM_Paper.pdf.

[52] Becker, Huselid, and Beatty, loc. cit.

[53] Huselid, loc. cit.

[54] Waldman, J., F. Kelly, S. Arora, and H. Smith. “The Shocking Cost of Turnover in Health Care.” Health Care Management Review 29 (2004): 2-7.

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2011 Volume 14 Issue 4

• Editor’s Note
• Financial Swiss Army Knife: A User-Friendly Tool for Facilitating Financial Analysis and Due Diligence
• Achieving Enterprise Stability Based on Economic Capital
• The Internet and Globalization: Ten Tips to Building an Effective Digital Strategy for Global Success
• Learn to Expect the Unexpected in Global Retail Expansion
• VIDEO: Stop the Madness: A Recipe to Jump-Start the Global Economy
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• Dean’s Executive Leadership Series

2011 Volume 14 Issue 3

• Editor’s Note
• Labor Pains: The Recovery of the U.S. Labor Market is about to be Pushed Back
• Creating Advocates: A Values-Oriented Approach to Developing Brand Loyalty
• Leveraging Action Learning as a Talent Management Strategy during Economic Uncertainty
• Protecting Descriptive Brands in Trademark and Trade Dress Law:
• VIDEO: Transforming the Relationship between Business and IT Executives
• The Book Corner

2011 Volume 14 Issue 2

• Editor’s Note: Finding Distinctiveness
• Secondary Meaning in Trademark and Trade Dress Law
• Financial Elements of Business Resilience
• Positive Organizational Scholarship and Practice: A Dynamic Duo
• VIDEO: Currency Wars, a Faculty Panel
• The Book Corner

2011 Volume 14 Issue 1

• Editor’s Note
• A Consequence Analysis that Needs to be Shared
• Family Business Succession
• The Quest for Distinctiveness in Trademark and Trade Dress Law
• Self-Organizing Conversation as an Invitation to Serendipity
• The ABC’s of Effective Feedback
• “Spiritual Capital and Virtuous Business Leadership” with Yale’s Ted Malloch
• “The Role of the CIO” with Harvey Koeppel
• The Book Corner

2010 Volume 13 Issue 4

• Attn: The Corner Office – Why U.S. Firms Should Pay Special Dividends Before Year-End 2010
• The Charisma of Twitter
• Lessons from the New Dodd-Frank Financial Regulatory Reform Law
• The Changing Role of the Residential Real Estate Broker
• 2010 Student Paper Winner: Using Social Media to Grow Your Business
• Editor’s Note: New Look, New Name, Still Great Content
• What to Do when Traditional Diversification Strategies Fail – Revisited
• Great Leaders are Great Decision-Makers
• The Four Levels of Innovation
• The Book Corner

2010 Volume 13 Issue 3

• The Spoiled American
• Choosing Your Negotiation Site
• Editorial: Systems Thinking
• Improvisation as a Way of Dealing with Ambiguity and Complexity
• Economic Recovery Gaining Traction
• The Book Corner
• City National Bank’s Robert Iritani Discusses the Future of Financial Management
• An Interview with Clean Tech Start-up Advisor Susanna Kass
• Servanthood Leadership

2010 Volume 13 Issue 2

• Carl Schramm Talks Expeditionary Economics
• Highly Effective Technical Personnel Strategies
• Real Options: The Value Added through Optimal Decision Making
• 10 Lessons for Entrepreneurs
• Utilizing Business Service Management Concepts to Improve Healthcare Information Services
• Editor’s Note
• Strategies for Leading through Times of Change
• Editorial: Will commercial real estate will follow in the footsteps of the residential property market?
• The Book Corner

2010 Volume 13 Issue 1

• Six Steps for Confronting the Emerging Leadership Succession Crisis
• Interview with Robert Eckert, Chairman of the Board and CEO of Mattel, Incorporated
• Political Connections: The Missing Dimension in Leadership
• How Coach, H-P, Zara, and Ford Profited from a Comprehensive Application of Market Orientation
• Three Ways Larger Monitors Can Improve Productivity
• The Role of Finance in the Strategic-Planning and Decision-Making Process
• Editorial: Is Robotics America’s Ticket to Continued Global Competitiveness?
• The Power of Collective Wisdom and the Trap of Collective Folly By Alan Briskin, Sheryl Erickson, John Ott, and Tom Callanan
• The Book Corner

2009 Volume 12 Issue 4

• Women, the Recession, and the Impending Economic Recovery
• The Power of Sharing in an Uncertain World
• How to Communicate Change to Employees
• Five Tactics to Create a Sustainable Restaurant Business
• IT Solutions for SMBs in an Economic Downturn
• What’s Next, Hollywood?
• Eight Key Attributes of Effective Leaders
• What to Do When Traditional Diversification Strategies Fail
• Video Interview on Corporate Social Responsiblitiy with Golden State Foods

2009 Volume 12 Issue 3

• Offshoring May Slow Impending U.S. Economic Recovery
• In Memory of Luis Villalobos
• IT Outsourcing: China Grasps for the Lead
• The Buffett Approach to Valuing Stocks
• Audio Interview with McKesson U.S. Pharmaceutical President John Figueroa
• Editorial: E-Learning is Green Learning
• The Book Corner

2009 Volume 12 Issue 2

• The Root Causes of Unethical Behavior
• Price Fixing and Minimum Resale Price Restrictions Are Two Different Animals
• Investing for Income in a Down Economy
• What Determines Which Businesses Win and Which Lose?
• Editorial: Writing a Business Plan to Attract Investors
• What’s Next LA: The Road to Economic Recovery
• Owner-Occupied Commercial Real Estate for the Entrepreneur
• The Winner’s Curse and Optimal Auction Bidding Strategies
• The Book Corner

2009 Volume 12 Issue 1

• Private vs. Public Real Estate Markets
• More Than Money: Interview with social entrepreneur Mark Albion
• The Successful Expatriate Leader in China
• Recognizing Organizational Culture in Managing Change
• Editorial: Taking Advantage of California’s Retirees to Help Close the Budget Gap
• Believe It: Complaints Are Gifts
• Active Alpha Portfolio Management
• Active Alpha Portfolio Management: Appendix A
• Active Alpha Portfolio Management: Appendix B
• The Book Corner

2008 Volume 11 Issue 4

• Best Practices for Headcount Reporting
• 2008 Graziadio School Student Paper Competition – How Intercultural Competence Drives Success in Global Virtual Teams
• Discovering Leadership Potential
• Discovering Leadership Potential – Evaluation Guidelines
• Corporate Governance, SOX, and the Business Judgment Rule
• What Will The International Financial Reporting Standards (IFRS) Mean to Businesses and Investors?
• Who are Fannie Mae and Freddie Mac?
• Crisis in America: A Nation at Risk
• The End of the Beginning for the Global Credit Crisis
• The Book Corner
• All IFRS-Compliant Statements Are Not Equal

2008 Volume 11 Issue 3

• The Book Corner
• IT-Enabled Information Transparency: A Strategic Approach
• Editor’s Note: The Top 10 Embracements for Difficult Economic Times
• Servicing the Software Industry (SaaS)
• Where Do Older Workers Go?
• Creating Wealth in Low Income Communities
• Supplier Diversity and Competitive Advantage: New Opportunities in Emerging Domestic Markets
• The Last 100 Feet of the Supply Chain
• America’s Financial Crisis

2008 Volume 11 Issue 2

• The Tie-In Decision
• The Trybaby Syndrome
• California Greening: Boom or Bust?
• High CEO Pay Could Draw Renewed Attention in Election Year
• Empowering Employees to Success
• Commercial Banking and Treasury Management in Mexico

2008 Volume 11 Issue 1

• Venture Capital Audio Interview
• Learning to Love Financial Market Barbarians
• The Top 10 U.S. Economic Issues to Monitor
• Putting Performance and Happiness Together in the Workplace
• In Memory of Robert Hockenberg
• Harassment Prevention Training 2008
• Editorial: No Child Left Behind-A Blueprint for Success
• A Class with Drucker by William A. Cohen
• The Book Corner
• Is Managed Futures an Asset Class?

2007 Volume 10 Issue 4

• Organizational Design and Implementation
• Managing the Critical Role of the Warehouse Supervisor
• Editor’s Note
• Creating a Community in Southern California that Values Sharing Knowledge
• The Book Corner
• Commercial Banking in the U.S. Versus Canada

2007 Volume 10 Issue 3

• Developing a Barometer for Workplace Attitude (WPA)
• The Employers’ Legal Obligations to Employees in the Military
• Employee Incentives
• Will the Sub-Prime Meltdown Burst the Housing Bubble?
• Strategic Leadership – Part Two
• Editor’s Note
• Assertive Performance Feedback
• To Tell or Not to Tell?
• The Book Corner

2007 Volume 10 Issue 2

• The Trader Joe’s Experience
• Strategic Leadership
• Managing Organizational Knowledge
• The Family-Owned Business
• Editor’s Note
• Emotional Dynamism: Playing the Music of Leadership
• Benefits of International Portfolio Diversification
• Aligning Business with a Value Statement
• The Book Corner

2007 Volume 10 Issue 1

• The Death of Time and Distance
• The Moral and Financial Conflict of Socially Responsible Investing
• What You Need to Know about Labor Shortages
• Women Entrepreneurship
• SEC Quest to Regulate Hedge Funds Hits Speed Bump
• The Book Corner

2006 Volume 9 Issue 4

• Seasonality and the Stock Market
• Airline Industry Key Success Factors
• Seven Neurotic Styles of Management
• IT in Healthcare
• Wings of the Great Northwest
• Gratitude at Work
• Editor’s Note
• The Book Corner
• Alternative Dispute Resolution

2006 Volume 9 Issue 3

• Making Marketing Accountable
• Conversations about Conscientious Capitalism
• Gen Y and Organizational Life
• Class Action Shareholder Suits Face Legal Setbacks
• The Book Corner
• Achieving Corporate Success and Maximized Value
• New: GBR Blog Videos

2006 Volume 9 Issue 2

• Business Survival Skills
• Six Components of a Model for Workplace Spirituality
• HR’s Strategic Partnership with Line Management
• The Book Corner
• Obesity, Social Responsibility, and Economic Value
• Graziadio Faculty Discuss Ethics

2006 Volume 9 Issue 1

• A Winning Tool to Manage Price: The Pricing Checklist
• Update: The Price of Oil
• Mapping IT Resources for Successful Implementations
• Is the Real Estate Market a House of Cards?
• Whither Now Dow?
• The Book Corner

2005 Volume 8 Issue 4

• Whistleblowers
• Editorial: Does a Non-Public Business Need SOX?
• IT Matters
• A New Imperative for Management: Sexual Harassment Training
• The Company Director’s Role In Company Growth
• Editor’s Note
• The Book Corner
• Fair Trade or Strategic Concern: The Unocal War

2005 Volume 8 Issue 3

• The IT Governance Road Map
• Avoiding Ethical Misconduct Disasters
• The Positive Psychology Approach to Goal Management
• Antitrust Law in the European Union
• Editor’s Note
• The Book Corner
• D & O Policies: Greater Risks Less Coverage
• A Blueprint for Change: Appreciative Inquiry

2005 Volume 8 Issue 2

• Connecting Enterprise Information and People in a Web World
• The Leader’s Role in Strategy
• The Practical Nuances of Leadership
• Editor’s Note
• Corruption Across Borders
• Resolving Intra-Organization Conflicts
• An Uphill Battle
• Leading and Managing Change
• The Book Corner

2005 Volume 8 Issue 1

• The Link Between Price and Profit Margin in a Global Market
• IT MATTERS
• The Impact of Empowered Employees on Corporate Value
• What You Need to Know about Attorneys’ Fees
• Editor’s Note – Phishing
• The Book Corner
• Strengthening Value-Centered Ethics (Part 3)
• Will Your Company’s Electronic Records Storage Withstand Legal Scrutiny? – Graziadio Business Review
• Conversation on Leadership with Jeff Shell

2004 Volume 7 Issue 3

• Litigate or Arbitrate?
• Presidential Elections and Stock Market Cycles
• Businesspersons Beware: Lying is a Crime
• Strengthening Value-Centered Ethics (Part 2)
• Attempting to Control Health Care Costs – Again
• Editor’s Note
• The Crude Facts About the Price of Oil
• Conversation with Stephen Baum
• The Book Corner
• The Uncertain World of Trademark Dilution

2004 Volume 7 Issue 2

• Does Corporate Social Responsibility Pay Off
• Strengthening Values Centered Leadership
• The Twin Deficits
• GBR Conversation with Robert Miller
• The Book Corner
• From Michelangelo to the Modern Boardroom
• Preparing for a Future Labor Shortage

2004 Volume 7 Issue 1

• Slowing Runaway Juries
• Merger and Acquisition Strategies
• Slips, Trips, and Falls
• Using Conflict to Your Advantage
• Wired
• Editorial – Don’t Panic!
• Seek and You Might Find
• GBR Conversation with Tom Ross
• The Dollar vs. the Euro
• The Book Corner

2003 Volume 6 Issue 4

• Negotiating Effectively
• Why Good Leaders Do Bad Things
• Editorial: Cybersatire
• Main Street and Hedging
• E-Business at the Graziadio Business Review
• What Stays and Who Pays?
• Inflation to Deflation and Back?
• Conversation with Betsy Bernard
• The Car Deal
• The Book Corner
• Using Dashboard Based Business Intelligence Systems

2003 Volume 6 Issue 3

• The Cost of Lost Data
• Consolidate All IT?
• Blowing the Whistle
• Creating and Sustaining an Ethical Workplace Culture
• Editorial – Onward and Upward?
• IT Matters: Portal Combat
• Facing Up to the Possibility of Deflation
• Dialogue With Four Executives

2003 Volume 6 Issue 2

• Hedging Strategies for Uncertain Times
• Do Not Call!*
• Improving R and D Performance Teamwork trumps solo endeavors
• Just-in-Time to Just-in-Case
• Increasing the Firm’s Strategic IQ
• Special Purpose Entities
• Shock and Awe
• IT Matters: Webhosting
• Conversation with Bert Boeckmann

2003 Volume 6 Issue 1

• Communicating Your Strategy
• Reforming Corporate America
• Recognize the True Cost of Compensation
• Learn from Experience
• Use Emotional Intelligence to Cope in Tough Times
• Conversation with Lacy Edwards of Evoke Software
• Editorial
• Predicting Bankruptcy in the WorldCom Age

2002 Volume 5 Issue 4

• Build Value in a Small Business
• Protect Your Trade Secrets
• Managing in an Era of Multiple Cultures
• Pros and Cons of Expensing Stock Options
• IT Matters: Web Services May Bridge the Great Culture Gap
• Editor’s Note
• Conversation with Paul Orfalea
• Calculating the Strategic Value of Customer Satisfaction

2002 Volume 5 Issue 3

• Encourage Your Employees to Play
• Managerial Leadership at Twelve O’Clock
• Remembering George L. Graziadio
• Editor’s Note: Bad Boys in the Board Room
• Who’s Driving American Firms?
• Supreme Court Sides With Business
• Using Asset Allocation Strategies to Recover from a Bear Hug
• Mediate, Arbitrate or Litigate?
• IT MATTERS: The Wonderful World of the Wireless Web

2002 Volume 5 Issue 2

• Will China Float the Yuan?
• Does Market Efficiency Trump Behavioral Bias in Finance Decisions?
• Making Mergers a Growth Strategy
• Sealing Cracks in the Capital Markets
• Artificial Intelligence Techniques Enhance Business Forecasts
• Editor’s Note: Weapons of Mass Disruption
• E-Commerce Reboots
• IT MATTERS: Web Services Prevail Despite Travail
• Go Directly to Jail?
• GBR CONVERSATION With John Shields

2002 Volume 5 Issue 1

• Build a Culture of Value Creation
• Choose Tomorrow’s Leaders Today
• Small Firms Keep R&D Vibrant
• Teams Use IT to Manage Client Impressions
• Putting Spirituality to Work
• IT MATTERS: Fifty Years and Counting
• Defining Disability Under the ADA
• GBR Conversation With Joe Rokus
• Editor’s Note: Decisions, Decisions, Decisions

2001 Volume 4 Issue 4

• Gender Impacts Virtual Work Teams
• Doing Business in a Volatile World
• The Strategic Downside of Downsizing
• Editor’s Note: Corporate Citizenship in the Wake of September 11!
• The Economic Downturn is No Surprise
• IT MATTERS: ROI for Tech Deployments in the Downturn
• Supreme Court Faces Key Business Cases
• GBR Conversation with Michael Josephson
• Are Workplace Bullies Sabotaging Your Ability to Compete?

2001 Volume 4 Issue 3

• Suddenly Unemployed?
• Too Late for an IPO?
• Electricity Price Gouging in California?
• Editor’s Note: Surf’s Up!
• The Fine Art of Delegation
• Waiting Games People Play
• Business at the Bar
• GBR Conversation with Senator Sandra Bowen

2001 Volume 4 Issue 2

• Knowledge Management and Business Portals
• Trust as a Competitive Advantage
• Is Price Everything?
• Editor’s Note: A Quarter Without Quarter
• Has the Dow Really Escaped the Bear?
• Dot.Gone
• IT MATTERS: E-Business is Definitely an E-Ticket Ride!
• Downsizing with Dignity
• GBR Conversation Mitchell J. Held
• The California Electricity Crisis

2001 Volume 4 Issue 1

• Repetition Leads To Innovation
• What’s the Problem?
• Editor’s Note: Quakes, Flakes, and Double Takes
• IT MATTERS: CRM Solution Seekers Beware!!!!
• Language, Culture and Global Business
• GBR Conversation Dr. Clyde Oden Jr.
• Personality Traits and Workplace Culture
• Who Wants to Lose a Million?
• The Power of Performance Profiling

2000 Volume 3 Issue 4

• Building Wealth
• How Small Firms Plan to Grow
• Using Internet Portals to Manage the Information Deluge
• Editor’s Note: Messy Brains and Global Opportunities
• SEC Requires Fair Disclosure
• IT MATTERS: MP3.com Completes Settlements
• GBR Conversation with Boyd Clarke
• Planning in a Complex World
• Business Be Advised!

2000 Volume 3 Issue 3

• Do Japan’s High Tech Failures Open Doors for Western Firms?
• Managing Earnings … or Cooking the Books?
• The Battle Over Merger Accounting – Graziadio Business Review
• GBR Conversation with senior economist
• Editor’s Note: Friends, Romans & Countrymen…
• What Directors Need to Know
• Still Thinking of Doing an IPO?

2000 Volume 3 Issue 2

• Managing Innovation through Corporate Venturing
• The Death of the Sales Force
• Thinking of Doing an IPO?
• Serving Each Other on the Inside
• Editor’s Note: Screaming Into the Future!
• GBR Conversation with Stephen J. Goldman
• Will Marketers Survive the Information Age?

2000 Volume 3 Issue 1

• Re-Assessing the Health of the Asian Tigers
• Knowledge Management and the Internet
• The Learning Organization in Practice
• Economic Forecasting
• Editor’s Note: A Short Hello!
• Are You Ready for E-Commerce?
• E-Business: The New Management Challenge
• GBR Conversation with Raytheon’s Daniel Burhnam
• The Bull Market’s Flawed Foundation

1999 Volume 2 Issue 4

• The Electric Day Trader and Ruin
• Teambuilding for Competitive Advantage
• Parable of the Commons
• Preserve and Strengthen a Business Partnership
• Editor’s Note: Here to Be Thrilled!
• GBR Conversation with Mike Roberts
• Telecommuting… Out of Sight, Out of Mind?
• Balancing Act for Employers in Today’s Labor Market
• Editor’s Note: Too Much Fun!

1999 Volume 2 Issue 3

• How Gerber Used a Decision Tree in Strategic Decision-Making
• Customer Satisfaction Measurement
• Get Your Message Across!
• E-Commerce & Taxation
• GBR Conversation with Dr. Gary Hamel
• To Join or Not To Join..?
• T.I.P.S.

1999 Volume 2 Issue 2

• Defamation Vs. Negligent Referral
• Maximize Business Achievement
• Preserving Family & Business Assets – Graziadio Business Review
• Knowledge is Power…
• Editor’s Note: Welcome to the Graziadio Business Review
• E-Commerce & Taxation
• GBR Conversation with Wayne “Buz” Knyal
• Cultivating the Customer Asset
• Decision-Making in a Global Environment

1999 Volume 2 Issue 1

• Business and Universities Moving to Collaborative Technologies
• Tips for Reducing Executive Stress
• Russia at the Crossroads
• Editor’s Note: Volume I, Issue 4
• GBR Case Study
• Launching an Effective Citizen Advisory Panel

1998 Volume 1 Issue 3

• Retirement Call to Action
• The European Directive On Data Privacy
• Editor’s Note: Welcome to the GBR, Volume I, Issue 3
• Debt Tied to Lower Firm Performance
• A conversation with Angelo Mozilo
• Boosting Country Club Memberships With Innovative Marketing and Pricing Concepts

1998 Volume 1 Issue 2

• Management Skills for the 21st Century
• Middlaning
• Editor’s Note: Welcome to the GBR, Volume I, Issue 2
• A conversation with Jeffrey Rigsby
• Cultural Insights on Doing Business in China
• When Worlds Collide

1998 Volume 1 Issue 1

• Editor’s Note: Welcome to the GBR
• Guide to Personal Investment Software
• Southeast Asia: Crisis To Recovery
• Growth Strategies for High Tech Firms
• A conversation with George L. Graziadio
• The Human Realities of Corporate Downsizing
• AB Corporation Case Study

Secondary Meaning in Trademark and Trade Dress Law

Why are descriptive terms treated so differently from fanciful, arbitrary, and suggestive marks? In a word: competition.

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Recognize the book? Familiar with the bird? Can the outline of an egg-laying vertebrate be protected as a trademark—and a book cover as trade dress?[1]

The answer—per Bach v. Forever Living Products (FLP)—is yes. In Bach, it was established that the defendant (FLP) had used “copyrighted photographs from Jonathan Livingston Seagull as their corporate logo, and … copyrighted excerpts from Jonathan Livingston Seagull … in their advertising, promotional, and training materials, in communications with their independent distributors, in their sale and distribution of FLP products, and in the advertising, marketing and promotion of Forever Resorts recreational properties.”[2] The plaintiff, author Richard Bach, had never registered any trademarks in connection with Jonathan Livingston Seagull.[3] Generally, when no trademark has been registered, the plaintiff bears the burden of proving the validity and protectability of his or her unregistered marks.[4] In this case Bach was able to meet that burden by establishing that his book’s images and text had acquired something called secondary meaning.[5] In this article, the second in a series focused on trademarks and trade dress, we detail the doctrine of secondary meaning and its ramifications for businesses.

What is Secondary Meaning?

As discussed in our previous article, “The Quest for Distinctiveness in Trademark and Trade Dress Law,” terms and symbols used by companies as elements of their trademark (mark) or trade dress (dress) fall into various categories with varying degrees of legal protection. The first three categories—fanciful, arbitrary, and suggestive terms—are inherently distinctive and are automatically protected. Conversely, those that are generic receive no legal protection. Descriptive terms, however, occupy a middle ground and must acquire secondary meaning before they can be protected.

To maintain an action for infringement,[6] a plaintiff must demonstrate that (1) its mark and/or dress are distinctive of its product’s source, (2) its mark and/or dress is nonfunctional, and (3) a likelihood of confusion exists between its product and the allegedly infringing defendant’s product.[7] The key issue is distinctiveness,[8] with the crucial test being “whether the mark serves as an indicator of source.”[9] When distinctiveness is not inherent (because, for example, a term or image is not fanciful, arbitrary, or suggestive), that term or image can acquire distinctiveness only by acquiring a secondary meaning.

Defining Secondary Meaning

Secondary meaning exists when a term that otherwise describes a product has become so affiliated with a specific product’s maker that it has taken on a second meaning.[10] Importantly, “[a]cquired distinctiveness is known as ‘secondary meaning’ not because it is second in importance or in impact, but because it is a meaning acquired second in time . . . to the original primary meaning of the designation.”[11] As explained by trademark expert J. Thomas McCarthy, “secondary meaning requires only that customers associate the word or symbol with a single, albeit anonymous, commercial source. The more descriptive and the less inherently distinctive the word, symbol, or trade dress, the greater the quantity and quality of evidence of secondary meaning must be to prove that level of distinctiveness necessary to achieve trademark, service mark, or trade dress status.”[12]

Acquiring Secondary Meaning

Generally, there are two ways to acquire secondary meaning: first, if a term or image is used exclusively and continuously for five years; second, if evidence demonstrates that the term or phrase has become uniquely associated with a particular company. Such evidence can include direct consumer testimony or survey evidence; records that demonstrate the exclusivity and length of use of a term or image; the amount and manner of advertising; the amount of sales and number of customers; the term or image’s established place in the market; or proof of intentional copying by the defendant.[13] However, not all words and images qualify for protection even if they acquire secondary meaning; these include national symbols, some names, and those that are immoral or scandalous.[14]

In Bach, the plaintiffs were able to demonstrate secondary meaning had accrued such that their mark and dress should be protected from unauthorized use: “Plaintiffs have submitted . . . that Jonathan Livingston Seagull is one of the most widely read novels of all time. [It has] sold over 13 million copies, spent 38 weeks at Number 1 on the New York Times best-seller list, and has been translated into more than 20 languages. Plaintiffs also [established] that FLP intentionally plagiarized the Jonathan logo and used it to attract and retain its distributors and to motivate them to sell its products. For example, FLP used the same image of a white seagull on a blue background, and called that logo ‘Jonathan,’ on its sales folders, banners, flags, and website.”[15] On these bases, the court found in favor of the plaintiffs and held FLP had infringed on their rights.

Next we discuss the various categories of marks recognized by the USPTO, focusing on descriptive marks and their relationship to secondary meaning.

Descriptive Marks

A relatively high degree of legal protection is automatically awarded to fanciful, arbitrary, and suggestive terms used as marks, since there is minimal risk that consumers will mistake the source of a product when confronted with them. By comparison, a term or symbol used as a trademark is descriptive and needs secondary meaning if it describes an ingredient, quality, characteristic, function, purpose, or particular use of the relevant goods and/or services. Such marks may describe a particular product’s qualities (like Easy Off [16]), a recognizable feature (Yellow Pages), or a comprehensive attribute (such as Super Glue).

Using (and protecting) a descriptive mark can be risky. In Genesee Brewing v. Stroh Brewing,[17] the plaintiff used the phrase Honey Brown on its lager product while the defendant used Honey Brown on its ale product. The court stated: “When a [second] producer creates a new product, trademark law will not grant the [first] producer the exclusive right to label its product with words that are necessary to describe (italics added) that new characteristic.”[18] The court ultimately held that the defendant had the right to add honey to its brown ale and call it exactly what it was: Honey Brown ale.

As noted in our earlier article, a logo that includes a geographic reference may also be considered descriptive and therefore require secondary meaning. For example, in Great Southern Bank v. First Southern Bank, the plaintiff sued the defendant—which had opened its doors two years later and 20 miles away—for using the term Southern in its corporate name. The court held that Southern is geographically descriptive, “not inherently distinctive,” of the origins of goods and services. Specifically, “geographically descriptive names used as names of businesses require proof of secondary meaning for legal protection.”[19] The court explained, “[D]escriptive geographical terms are in the public domain in the sense that every seller should have the right to inform customers of the geographical origin of his goods.”[20] Thus, the plaintiff couldn’t stop the defendant from using Southern.

However, in another geography case, Tortoise Island Homeowners Ass’n v. Tortoise Island Realty,[21] the plaintiffs (a homeowners’ association) sued the defendant (a realty company) for trademark infringement. The defendant argued that the plaintiff needed to prove that secondary meaning had attached to Tortoise Island to prevent use of the phrase. There, the appellate court found that Tortoise Island was not descriptive but was a name that had been devised for the subdivision by the developer in reference to the many species of tortoises in the area. Therefore, it was an arbitrary moniker that did not require a showing of secondary meaning for protection.[22]

Why are descriptive terms treated so differently from fanciful, arbitrary, and suggestive marks? In a word: competition. Because descriptive terms can be used to describe many products and their sources, to grant a particular marketer the exclusive right to use them could confer an unfair advantage. However, descriptive terms can be protected as trademarks if, after time and advertising, they become uniquely associated with a single company.[23] “Given that competitors can only be prohibited from using a descriptive term once it achieves secondary meaning, a plaintiff in a trademark infringement case has the burden of establishing secondary meaning,”[24] i.e., that it “has become distinctive of the applicant’s goods in commerce.”[25]

In 1969 the term Park’N Fly was accepted and filed by the USPTO[26] despite the fact that it seemed to be descriptive of airport parking. Nearly six years later, Park’N Fly filed an affidavit with the USPTO to establish the incontestable status of the mark.[27] Incontestable status provides “conclusive evidence of the registrant’s exclusive right to use the registered mark”[28] and prevents others from legally using it. Subsequently, Park’N Fly sued defendant Dollar Park’n Fly, Inc. for trademark infringement. Dollar counterclaimed that the phrase Park’N Fly was “merely descriptive” and should be disallowed as a mark. However, the Supreme Court held that “the holder of a registered mark may rely on incontestability to enjoin infringement.”[29] Thus, “incontestability” trumped any independent analysis of the mark’s descriptiveness.

Despite this holding, we agree with the defendants that Park’N Fly probably is a descriptive phrase that should not have been protected without proof of secondary meaning.[30] This case clearly illustrates the problem of permitting the registration of descriptive marks. What should the defendant have named his business—Leave auto here ‘N get on plane? To distinguish among competitors, additional terms can easily be inserted, such as Dollar (Dollar Park’n Fly), Discount (Discount Park’n Fly), or even Dave (Dave’s Park’n Fly).

This last example raises the next important topic: personal names.

Personal Names

Generally, “personal names are regarded as in the same category as descriptive terms” and “are placed by the common law into that category of noninherently distinctive terms which require proof of secondary meaning for protection.”[31] The underlying logic is that no one should be prohibited from using his or her name to promote a product or service just because someone else used it first.[32] One particularly notorious case arose when NBA Hall-of-Famer Kareem Abdul-Jabbar sued Miami Dolphins’ running back Karim Abdul-Jabbar (the former Sharmon Shah) to stop him from using his very similar name because of the potential for confusion.[33] Their settlement dictated that Karim could use only the name Abdul on his jersey, not Abdul-Jabbar, as long as he continued to play for the Dolphins. In 2000, probably to avoid any further hassles, Karim changed his name to Abdul-Karim al-Jabbar.

Conclusion

The lasting impact of the Bach case and Jonathan as an unregistered trademark is that the bird can be protected, but “only upon a showing of secondary meaning.”[34] But, “whether a [mark] has acquired secondary meaning is a question of fact.”[35] Secondary meaning arises and attaches when, “in the minds of the public, the primary significance of a [mark] is to identify the source of the product rather than the product itself.”[36] Lastly, the burden of proving secondary meaning rests with the plaintiff, but usually only becomes an issue with descriptive marks. By comparison, fanciful, arbitrary, and even suggestive marks can almost always be automatically protected through registration.[37]

In “Protecting Descriptive Brands: Why it’s Important and How to Do It,” our next and final article in this series, we discuss how to prove that secondary meaning has attached to your trademark, should you need to.

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2011 Volume 14 Issue 4

• Editor’s Note
• Financial Swiss Army Knife: A User-Friendly Tool for Facilitating Financial Analysis and Due Diligence
• Achieving Enterprise Stability Based on Economic Capital
• The Internet and Globalization: Ten Tips to Building an Effective Digital Strategy for Global Success
• Learn to Expect the Unexpected in Global Retail Expansion
• VIDEO: Stop the Madness: A Recipe to Jump-Start the Global Economy
• The Book Corner
• Video Library
• Graziadio School Business Programs
• Dean’s Executive Leadership Series

2011 Volume 14 Issue 3

• Editor’s Note
• Labor Pains: The Recovery of the U.S. Labor Market is about to be Pushed Back
• Creating Advocates: A Values-Oriented Approach to Developing Brand Loyalty
• Leveraging Action Learning as a Talent Management Strategy during Economic Uncertainty
• Protecting Descriptive Brands in Trademark and Trade Dress Law:
• VIDEO: Transforming the Relationship between Business and IT Executives
• The Book Corner

2011 Volume 14 Issue 2

• Editor’s Note: Finding Distinctiveness
• Secondary Meaning in Trademark and Trade Dress Law
• Financial Elements of Business Resilience
• Positive Organizational Scholarship and Practice: A Dynamic Duo
• VIDEO: Currency Wars, a Faculty Panel
• The Book Corner

2011 Volume 14 Issue 1

• Editor’s Note
• A Consequence Analysis that Needs to be Shared
• Family Business Succession
• The Quest for Distinctiveness in Trademark and Trade Dress Law
• Self-Organizing Conversation as an Invitation to Serendipity
• The ABC’s of Effective Feedback
• “Spiritual Capital and Virtuous Business Leadership” with Yale’s Ted Malloch
• “The Role of the CIO” with Harvey Koeppel
• The Book Corner

2010 Volume 13 Issue 4

• Attn: The Corner Office – Why U.S. Firms Should Pay Special Dividends Before Year-End 2010
• The Charisma of Twitter
• Lessons from the New Dodd-Frank Financial Regulatory Reform Law
• The Changing Role of the Residential Real Estate Broker
• 2010 Student Paper Winner: Using Social Media to Grow Your Business
• Editor’s Note: New Look, New Name, Still Great Content
• What to Do when Traditional Diversification Strategies Fail – Revisited
• Great Leaders are Great Decision-Makers
• The Four Levels of Innovation
• The Book Corner

2010 Volume 13 Issue 3

• The Spoiled American
• Choosing Your Negotiation Site
• Editorial: Systems Thinking
• Improvisation as a Way of Dealing with Ambiguity and Complexity
• Economic Recovery Gaining Traction
• The Book Corner
• City National Bank’s Robert Iritani Discusses the Future of Financial Management
• An Interview with Clean Tech Start-up Advisor Susanna Kass
• Servanthood Leadership

2010 Volume 13 Issue 2

• Carl Schramm Talks Expeditionary Economics
• Highly Effective Technical Personnel Strategies
• Real Options: The Value Added through Optimal Decision Making
• 10 Lessons for Entrepreneurs
• Utilizing Business Service Management Concepts to Improve Healthcare Information Services
• Editor’s Note
• Strategies for Leading through Times of Change
• Editorial: Will commercial real estate will follow in the footsteps of the residential property market?
• The Book Corner

2010 Volume 13 Issue 1

• Six Steps for Confronting the Emerging Leadership Succession Crisis
• Interview with Robert Eckert, Chairman of the Board and CEO of Mattel, Incorporated
• Political Connections: The Missing Dimension in Leadership
• How Coach, H-P, Zara, and Ford Profited from a Comprehensive Application of Market Orientation
• Three Ways Larger Monitors Can Improve Productivity
• The Role of Finance in the Strategic-Planning and Decision-Making Process
• Editorial: Is Robotics America’s Ticket to Continued Global Competitiveness?
• The Power of Collective Wisdom and the Trap of Collective Folly By Alan Briskin, Sheryl Erickson, John Ott, and Tom Callanan
• The Book Corner

2009 Volume 12 Issue 4

• Women, the Recession, and the Impending Economic Recovery
• The Power of Sharing in an Uncertain World
• How to Communicate Change to Employees
• Five Tactics to Create a Sustainable Restaurant Business
• IT Solutions for SMBs in an Economic Downturn
• What’s Next, Hollywood?
• Eight Key Attributes of Effective Leaders
• What to Do When Traditional Diversification Strategies Fail
• Video Interview on Corporate Social Responsiblitiy with Golden State Foods

2009 Volume 12 Issue 3

• Offshoring May Slow Impending U.S. Economic Recovery
• In Memory of Luis Villalobos
• IT Outsourcing: China Grasps for the Lead
• The Buffett Approach to Valuing Stocks
• Audio Interview with McKesson U.S. Pharmaceutical President John Figueroa
• Editorial: E-Learning is Green Learning
• The Book Corner

2009 Volume 12 Issue 2

• The Root Causes of Unethical Behavior
• Price Fixing and Minimum Resale Price Restrictions Are Two Different Animals
• Investing for Income in a Down Economy
• What Determines Which Businesses Win and Which Lose?
• Editorial: Writing a Business Plan to Attract Investors
• What’s Next LA: The Road to Economic Recovery
• Owner-Occupied Commercial Real Estate for the Entrepreneur
• The Winner’s Curse and Optimal Auction Bidding Strategies
• The Book Corner

2009 Volume 12 Issue 1

• Private vs. Public Real Estate Markets
• More Than Money: Interview with social entrepreneur Mark Albion
• The Successful Expatriate Leader in China
• Recognizing Organizational Culture in Managing Change
• Editorial: Taking Advantage of California’s Retirees to Help Close the Budget Gap
• Believe It: Complaints Are Gifts
• Active Alpha Portfolio Management
• Active Alpha Portfolio Management: Appendix A
• Active Alpha Portfolio Management: Appendix B
• The Book Corner

2008 Volume 11 Issue 4

• Best Practices for Headcount Reporting
• 2008 Graziadio School Student Paper Competition – How Intercultural Competence Drives Success in Global Virtual Teams
• Discovering Leadership Potential
• Discovering Leadership Potential – Evaluation Guidelines
• Corporate Governance, SOX, and the Business Judgment Rule
• What Will The International Financial Reporting Standards (IFRS) Mean to Businesses and Investors?
• Who are Fannie Mae and Freddie Mac?
• Crisis in America: A Nation at Risk
• The End of the Beginning for the Global Credit Crisis
• The Book Corner
• All IFRS-Compliant Statements Are Not Equal

2008 Volume 11 Issue 3

• The Book Corner
• IT-Enabled Information Transparency: A Strategic Approach
• Editor’s Note: The Top 10 Embracements for Difficult Economic Times
• Servicing the Software Industry (SaaS)
• Where Do Older Workers Go?
• Creating Wealth in Low Income Communities
• Supplier Diversity and Competitive Advantage: New Opportunities in Emerging Domestic Markets
• The Last 100 Feet of the Supply Chain
• America’s Financial Crisis

2008 Volume 11 Issue 2

• The Tie-In Decision
• The Trybaby Syndrome
• California Greening: Boom or Bust?
• High CEO Pay Could Draw Renewed Attention in Election Year
• Empowering Employees to Success
• Commercial Banking and Treasury Management in Mexico

2008 Volume 11 Issue 1

• Venture Capital Audio Interview
• Learning to Love Financial Market Barbarians
• The Top 10 U.S. Economic Issues to Monitor
• Putting Performance and Happiness Together in the Workplace
• In Memory of Robert Hockenberg
• Harassment Prevention Training 2008
• Editorial: No Child Left Behind-A Blueprint for Success
• A Class with Drucker by William A. Cohen
• The Book Corner
• Is Managed Futures an Asset Class?

2007 Volume 10 Issue 4

• Organizational Design and Implementation
• Managing the Critical Role of the Warehouse Supervisor
• Editor’s Note
• Creating a Community in Southern California that Values Sharing Knowledge
• The Book Corner
• Commercial Banking in the U.S. Versus Canada

2007 Volume 10 Issue 3

• Developing a Barometer for Workplace Attitude (WPA)
• The Employers’ Legal Obligations to Employees in the Military
• Employee Incentives
• Will the Sub-Prime Meltdown Burst the Housing Bubble?
• Strategic Leadership – Part Two
• Editor’s Note
• Assertive Performance Feedback
• To Tell or Not to Tell?
• The Book Corner

2007 Volume 10 Issue 2

• The Trader Joe’s Experience
• Strategic Leadership
• Managing Organizational Knowledge
• The Family-Owned Business
• Editor’s Note
• Emotional Dynamism: Playing the Music of Leadership
• Benefits of International Portfolio Diversification
• Aligning Business with a Value Statement
• The Book Corner

2007 Volume 10 Issue 1

• The Death of Time and Distance
• The Moral and Financial Conflict of Socially Responsible Investing
• What You Need to Know about Labor Shortages
• Women Entrepreneurship
• SEC Quest to Regulate Hedge Funds Hits Speed Bump
• The Book Corner

2006 Volume 9 Issue 4

• Seasonality and the Stock Market
• Airline Industry Key Success Factors
• Seven Neurotic Styles of Management
• IT in Healthcare
• Wings of the Great Northwest
• Gratitude at Work
• Editor’s Note
• The Book Corner
• Alternative Dispute Resolution

2006 Volume 9 Issue 3

• Making Marketing Accountable
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• Gen Y and Organizational Life
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• The Book Corner
• Achieving Corporate Success and Maximized Value
• New: GBR Blog Videos

2006 Volume 9 Issue 2

• Business Survival Skills
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• HR’s Strategic Partnership with Line Management
• The Book Corner
• Obesity, Social Responsibility, and Economic Value
• Graziadio Faculty Discuss Ethics

2006 Volume 9 Issue 1

• A Winning Tool to Manage Price: The Pricing Checklist
• Update: The Price of Oil
• Mapping IT Resources for Successful Implementations
• Is the Real Estate Market a House of Cards?
• Whither Now Dow?
• The Book Corner

2005 Volume 8 Issue 4

• Whistleblowers
• Editorial: Does a Non-Public Business Need SOX?
• IT Matters
• A New Imperative for Management: Sexual Harassment Training
• The Company Director’s Role In Company Growth
• Editor’s Note
• The Book Corner
• Fair Trade or Strategic Concern: The Unocal War

2005 Volume 8 Issue 3

• The IT Governance Road Map
• Avoiding Ethical Misconduct Disasters
• The Positive Psychology Approach to Goal Management
• Antitrust Law in the European Union
• Editor’s Note
• The Book Corner
• D & O Policies: Greater Risks Less Coverage
• A Blueprint for Change: Appreciative Inquiry

2005 Volume 8 Issue 2

• Connecting Enterprise Information and People in a Web World
• The Leader’s Role in Strategy
• The Practical Nuances of Leadership
• Editor’s Note
• Corruption Across Borders
• Resolving Intra-Organization Conflicts
• An Uphill Battle
• Leading and Managing Change
• The Book Corner

2005 Volume 8 Issue 1

• The Link Between Price and Profit Margin in a Global Market
• IT MATTERS
• The Impact of Empowered Employees on Corporate Value
• What You Need to Know about Attorneys’ Fees
• Editor’s Note – Phishing
• The Book Corner
• Strengthening Value-Centered Ethics (Part 3)
• Will Your Company’s Electronic Records Storage Withstand Legal Scrutiny? – Graziadio Business Review
• Conversation on Leadership with Jeff Shell

2004 Volume 7 Issue 3

• Litigate or Arbitrate?
• Presidential Elections and Stock Market Cycles
• Businesspersons Beware: Lying is a Crime
• Strengthening Value-Centered Ethics (Part 2)
• Attempting to Control Health Care Costs – Again
• Editor’s Note
• The Crude Facts About the Price of Oil
• Conversation with Stephen Baum
• The Book Corner
• The Uncertain World of Trademark Dilution

2004 Volume 7 Issue 2

• Does Corporate Social Responsibility Pay Off
• Strengthening Values Centered Leadership
• The Twin Deficits
• GBR Conversation with Robert Miller
• The Book Corner
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• Preparing for a Future Labor Shortage

2004 Volume 7 Issue 1

• Slowing Runaway Juries
• Merger and Acquisition Strategies
• Slips, Trips, and Falls
• Using Conflict to Your Advantage
• Wired
• Editorial – Don’t Panic!
• Seek and You Might Find
• GBR Conversation with Tom Ross
• The Dollar vs. the Euro
• The Book Corner

2003 Volume 6 Issue 4

• Negotiating Effectively
• Why Good Leaders Do Bad Things
• Editorial: Cybersatire
• Main Street and Hedging
• E-Business at the Graziadio Business Review
• What Stays and Who Pays?
• Inflation to Deflation and Back?
• Conversation with Betsy Bernard
• The Car Deal
• The Book Corner
• Using Dashboard Based Business Intelligence Systems

2003 Volume 6 Issue 3

• The Cost of Lost Data
• Consolidate All IT?
• Blowing the Whistle
• Creating and Sustaining an Ethical Workplace Culture
• Editorial – Onward and Upward?
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• Facing Up to the Possibility of Deflation
• Dialogue With Four Executives

2003 Volume 6 Issue 2

• Hedging Strategies for Uncertain Times
• Do Not Call!*
• Improving R and D Performance Teamwork trumps solo endeavors
• Just-in-Time to Just-in-Case
• Increasing the Firm’s Strategic IQ
• Special Purpose Entities
• Shock and Awe
• IT Matters: Webhosting
• Conversation with Bert Boeckmann

2003 Volume 6 Issue 1

• Communicating Your Strategy
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• Recognize the True Cost of Compensation
• Learn from Experience
• Use Emotional Intelligence to Cope in Tough Times
• Conversation with Lacy Edwards of Evoke Software
• Editorial
• Predicting Bankruptcy in the WorldCom Age

2002 Volume 5 Issue 4

• Build Value in a Small Business
• Protect Your Trade Secrets
• Managing in an Era of Multiple Cultures
• Pros and Cons of Expensing Stock Options
• IT Matters: Web Services May Bridge the Great Culture Gap
• Editor’s Note
• Conversation with Paul Orfalea
• Calculating the Strategic Value of Customer Satisfaction

2002 Volume 5 Issue 3

• Encourage Your Employees to Play
• Managerial Leadership at Twelve O’Clock
• Remembering George L. Graziadio
• Editor’s Note: Bad Boys in the Board Room
• Who’s Driving American Firms?
• Supreme Court Sides With Business
• Using Asset Allocation Strategies to Recover from a Bear Hug
• Mediate, Arbitrate or Litigate?
• IT MATTERS: The Wonderful World of the Wireless Web

2002 Volume 5 Issue 2

• Will China Float the Yuan?
• Does Market Efficiency Trump Behavioral Bias in Finance Decisions?
• Making Mergers a Growth Strategy
• Sealing Cracks in the Capital Markets
• Artificial Intelligence Techniques Enhance Business Forecasts
• Editor’s Note: Weapons of Mass Disruption
• E-Commerce Reboots
• IT MATTERS: Web Services Prevail Despite Travail
• Go Directly to Jail?
• GBR CONVERSATION With John Shields

2002 Volume 5 Issue 1

• Build a Culture of Value Creation
• Choose Tomorrow’s Leaders Today
• Small Firms Keep R&D Vibrant
• Teams Use IT to Manage Client Impressions
• Putting Spirituality to Work
• IT MATTERS: Fifty Years and Counting
• Defining Disability Under the ADA
• GBR Conversation With Joe Rokus
• Editor’s Note: Decisions, Decisions, Decisions

2001 Volume 4 Issue 4

• Gender Impacts Virtual Work Teams
• Doing Business in a Volatile World
• The Strategic Downside of Downsizing
• Editor’s Note: Corporate Citizenship in the Wake of September 11!
• The Economic Downturn is No Surprise
• IT MATTERS: ROI for Tech Deployments in the Downturn
• Supreme Court Faces Key Business Cases
• GBR Conversation with Michael Josephson
• Are Workplace Bullies Sabotaging Your Ability to Compete?

2001 Volume 4 Issue 3

• Suddenly Unemployed?
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• The Fine Art of Delegation
• Waiting Games People Play
• Business at the Bar
• GBR Conversation with Senator Sandra Bowen

2001 Volume 4 Issue 2

• Knowledge Management and Business Portals
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• Is Price Everything?
• Editor’s Note: A Quarter Without Quarter
• Has the Dow Really Escaped the Bear?
• Dot.Gone
• IT MATTERS: E-Business is Definitely an E-Ticket Ride!
• Downsizing with Dignity
• GBR Conversation Mitchell J. Held
• The California Electricity Crisis

2001 Volume 4 Issue 1

• Repetition Leads To Innovation
• What’s the Problem?
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• IT MATTERS: CRM Solution Seekers Beware!!!!
• Language, Culture and Global Business
• GBR Conversation Dr. Clyde Oden Jr.
• Personality Traits and Workplace Culture
• Who Wants to Lose a Million?
• The Power of Performance Profiling

2000 Volume 3 Issue 4

• Building Wealth
• How Small Firms Plan to Grow
• Using Internet Portals to Manage the Information Deluge
• Editor’s Note: Messy Brains and Global Opportunities
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• IT MATTERS: MP3.com Completes Settlements
• GBR Conversation with Boyd Clarke
• Planning in a Complex World
• Business Be Advised!

2000 Volume 3 Issue 3

• Do Japan’s High Tech Failures Open Doors for Western Firms?
• Managing Earnings … or Cooking the Books?
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• Still Thinking of Doing an IPO?

2000 Volume 3 Issue 2

• Managing Innovation through Corporate Venturing
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• Will Marketers Survive the Information Age?

2000 Volume 3 Issue 1

• Re-Assessing the Health of the Asian Tigers
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• E-Business: The New Management Challenge
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• The Bull Market’s Flawed Foundation

1999 Volume 2 Issue 4

• The Electric Day Trader and Ruin
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• Balancing Act for Employers in Today’s Labor Market
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1999 Volume 2 Issue 3

• How Gerber Used a Decision Tree in Strategic Decision-Making
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1999 Volume 2 Issue 2

• Defamation Vs. Negligent Referral
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1999 Volume 2 Issue 1

• Business and Universities Moving to Collaborative Technologies
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• Editor’s Note: Volume I, Issue 4
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1998 Volume 1 Issue 3

• Retirement Call to Action
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1998 Volume 1 Issue 2

• Management Skills for the 21st Century
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• When Worlds Collide

1998 Volume 1 Issue 1

• Editor’s Note: Welcome to the GBR
• Guide to Personal Investment Software
• Southeast Asia: Crisis To Recovery
• Growth Strategies for High Tech Firms
• A conversation with George L. Graziadio
• The Human Realities of Corporate Downsizing
• AB Corporation Case Study

Financial Elements of Business Resilience

In order to deal with business fluctuations, efforts to develop strategic resilience should extend to financial decision making, approached in a systematic manner.

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Business organizations exist within the context of larger market economies where conditions are always changing. For an organization to survive in the face of this constant change, Hamel and Valikangas recommend an organizational strategy of flexibility.[1] They advocate a strategic resilience, which is achievable when managers anticipate and adjust to changes that threaten a company’s core competencies. However, their suggestions for developing strategic resilience contain little guidance for incorporating financial decisions in the organization’s strategic deliberations.

Despite this omission, financial decision making is an important part of the process of making a business more resilient. In early 2011, a survey of 1,054 senior financial executives reported that 41 percent had an increase in their responsibilities related to strategy/business development in the past 18 months.[2] Other areas with significant increases included information technology, customer service, risk analysis, operations, and human resources. Such expansion in responsibilities of these finance specialists attests to the importance of considering financial elements in developing business resilience. This article outlines recommendations for doing so through a systematic approach to financial decisions that can positively impact strategic resilience.

Step 1: Require the Valuation of Flexibility

An initial step for financial analysis is the quantitative evaluation of a firm’s investment opportunities. But special care is required here. The traditional Net Present Value (NPV) computations, first made popular by Dean, assume that once an investment is made, a manager cannot revise the initial commitment of resources in order to change future cash flows.[3] These methods are still taught today, but they ignore flexibility. Many investments are not passive investments that are unchangeable once committed. Managers can and do act after initial investment commitments have been made to adjust the size and nature of cash flows when past assumptions about future conditions prove incorrect. To reflect the market value of such potential adjustments, Real Option Theory moves away from NPV’s assumption of a passive manager who no longer acts once an investment decision is made, to that of active management that permits managers to enact changes in resource commitments after initial investment is made. In this new view, total NPV of an investment opportunity is seen as a sum of two components: 1. The NPV with no revisions, plus 2. The NPV that is associated with possible revisions in commitments.

Real Option Theory offers financial assessment of the flexibility that facilitates a company’s strategic resilience capabilities. It provides a method to quantify the value of managerial flexibility so that a manager’s real options can become part of NPV analyses. This approach can be used for several different purposes.[4][5] In any of its investment-decision applications, Real Option Theory reflects the reality that managers are not passive, but are able to actively adjust company operations as unforeseeable future conditions unfold.

Real Options Theory is not always as simple to use as computation-guided approaches, such as traditional NPV. It invites subjective judgments as to what could happen instead of focusing only on what is most likely to happen. Think, for example, of putting only enough gasoline in an automobile to safely make a scheduled trip of 100 miles. A traditional NPV approach buys the minimum amount of gasoline because less gasoline reduces investment cost without jeopardizing the scheduled trip. Conversely, Real Options Theory leads management to consider the value of putting an extra amount of gasoline in the automobile—based on the probability that an unanticipated but potentially profitable side trip should be taken during the originally scheduled 100-mile trip. In other words, investing for just the scheduled 100-mile trip does not allow the flexibility to seize an attractive—but unexpected—opportunity. The value of this flexibility involves managerial judgments. The same holds true in evaluating a threat, such as getting a flat tire—would you make this trip without a spare tire? A strictly profit-maximizing approach may seek to reduce costs by recommending against purchasing a spare tire. What is the value of having a spare tire? This is the kind of judgment decision overlooked by traditional NPV calculations.

A company might invest in a power plant that can switch between natural gas and wood fiber in generating electricity so that future power needs can be satisfied by whichever method is cheaper. The initial cost of this switching flexibility might be high and so traditional capital budgeting calculations might favor low-cost, less flexible alternatives. But, if the other side of low-cost is an inability to cope with volatile fuel prices, then traditional methods give the wrong answer. Real Option Theory is a better tool, one that values flexibility, and its proper application will serve managers who desire to make their organizations more resilient to economic stress.

Step 2: Consider the Value of Magnitude and Reversibility

Real Option Theory, as understood by Brealey, Myers, and Allen, suggests that both the size of individual investments and whether or not these investments can be altered over time matter in terms of market value.[6] Why? Because investments that are scalable permit decision makers to follow initial successes with follow-on investments and to cut losses in the event of failure. This scalability, in and of itself, creates value that cannot be seen with traditional capital budgeting methods. Trigeorgis recognizes that decision makers using traditional capital budgeting tools are not valuing their own ability to take an active role in managing economic resources into the future.[7]

Investments that are reversible also create value. The flexibility of a firm is directly related to the degree that its investments are reversible. In any event, as a company takes steps to increase its resilience, it should expect to be able to afford more inflexibility in some of its investments.

Step 3: Remain Within Core Competencies

Strategic resilience comes at a cost, and managers may quickly find that its development places constraints on profits. Much like with other core competencies or “competitive advantages” of a company, resilience requires an investment to develop and maintain. Core competencies lead to a company’s success in its markets, and benchmarking against the competencies of competitors may mandate larger investments just to remain competitive. Even when financial analyses indicate that investments into certain core competencies are not fiscally prudent, managers may choose to make these investments because of strategic goals, such as staying at the forefront of some relevant technology.

Every company needs to ask itself what level of financial resources should be held in reserve? Different levels will be appropriate for different companies, and resilience may affect profits in different ways. The costs of developing resilience may reduce profits; however, resilience contributes to continued company survival. Choosing a specific level of a company’s strategic resilience requires periodic judgments that balance its value against its costs. Such judgments are further complicated by situations where resilience may actually increase profits by allowing a company to seize unexpected opportunities.

When performing financial analyses, managers need to consider how all of the company’s competencies can assist in their efforts. For example, a company may have a “captive buyer” for whom the company is the only possible source for its vital inputs. This kind of company could potentially pass cost increases along to its customers, thereby using its “marketing competency” to maintain financial resilience.

Alternatively, for a company that cannot pass its cost increases along to customers, hedging may be desirable. Hedging may reduce the future profits of a company, but it can allow this company to offer stable prices to customers at a profit for the long-term. Some companies have customers that expect stable prices, while others have customers that accept price fluctuations. For example, a coffee shop may hedge its purchases of coffee because its patrons expect to pay customary prices for standard sized cups. Conversely, a gasoline station operator might not hedge gasoline purchases because customers are used to paying fluctuating gasoline prices. The key is to leverage your strengths against economic uncertainty. Each company will need to assess its core competencies and strategize as to how they can be best utilized in developing the ultimate core competency of resilience.

Step 4: Restrain Financial Leverage

As a company selects investments, decisions regarding financing needs and capital structure can affect company resilience, and therefore require strategic consideration. For example, resilience will decrease as financial leverage increases, because large debts impose cash-flow burdens that reduce flexibility. This is especially troublesome for small businesses because of their tendency to rely on debt financing.

There are other aspects of capital structuring that are often considered, but managers of firms large and small should always remember that companies can increase their resilience by reinvesting profits back into the firm. Such equity can be used to grow the firm or to pay back borrowed money. Internal financing of growth avoids the possibility of immense debt burdens arising when a new “star” product’s sales grow rapidly. Large debts can develop because a company must usually pay for its production and distribution costs before the product can be purchased by customers. Customers may make matters worse if they further delay payment for their credit purchases. Rather than acquire a huge debt burden for financing a high-potential product’s growth, a small company may make a strategic decision to sell the star product to a larger company that can more safely handle the financing.

Step 5: Integrate Resilience into Operations

As a company implements strategic plans, financial managers should be alert for opportunities to use flexibility in the necessary operational activities. This is yet another tool to improve or preserve profits throughout the business cycle. Brealey, Myers, and Allen note that within the context of volatile product markets, the ability of a firm to alter the nature and quantity of inputs and outputs in response to changing prices creates shareholder value.[8] And this flexibility works to create value to the degree that prices are volatile—the greater the volatility in prices for inputs and/or outputs, the more valuable flexible production methods become. This flexibility can serve to offset some of the harm done when sales volumes are reduced.

C.K. Prahalad has studied companies in India that are able to deal with highly volatile business conditions by using “strategic clarity and consistency” to guide “agility and resilience in operations.”[9] He identifies companies that are able to succeed at 30 percent to 40 percent capacity utilization, noting that agility in changing operational activities is vital to resilience.

Conclusion

Any organization that possesses a core competency can succeed during times of economic prosperity. Only those that are resilient can survive economic change. Flexible organizations are able to adjust to economic fluctuations while keeping these core competencies intact. This flexibility must extend to the company’s capital investment policy. Managers who employ Real Option Theory can evaluate capital investment opportunities in terms of their flexibility, favoring capital commitments that do not put the future of the organization in jeopardy. This approach, followed by the aforementioned steps, will help optimize a company’s resilience through its financial decision-making processes. Traditional capital budgeting methods will not help managers to do this work.

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[1] Hamel, Gary, and Liisa Valikangas. “The Quest for Resilience.” Harvard Business Review 81, no. 9 (September 2003): 52-63.

[2] Mattioli, Dana. “Finance Chiefs Expand Roles,” Wall Street Journal, p. 87, January 31, 2011.

[3] Dean, Joel. Capital Budgeting. New York: Columbia University Press, 1951.

[4] Copeland, Tom, and Peter Tufano. “A Real-World Way to Manage Real Options.” Harvard Business Review 44, no. 3 (March 2004): 90-99.

[5] Ferreira, Nelson, Jayanti Kar, and Lenos Trigeorgis. “Option Games: The Key to Competing in Capital-Intensive Industries.” Harvard Business Review 87, no. 3 (March 2009): 101-87.

[6] Brealey, Richard A., Stewart C. Myers, and Franklin Allen. “Brealey, Myers, and Allen on Real Options.” Journal of Applied Corporate Finance 20, no. 4 (Fall 2008): 58-71.

[7] Trigeorgis, Lenos. Real Options: Managerial Flexibility and Strategy in Resource Allocation. Cambridge, MA: MIT Press, 1996.

[8] Brealey, Myers, & Allen, 2008, pp. 58-71.

[9] Prahalad, C. K. “In Volatile Times, Agility Rules.” BusinessWeek, September 21, 2009.

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2011 Volume 14 Issue 4

• Editor’s Note
• Financial Swiss Army Knife: A User-Friendly Tool for Facilitating Financial Analysis and Due Diligence
• Achieving Enterprise Stability Based on Economic Capital
• The Internet and Globalization: Ten Tips to Building an Effective Digital Strategy for Global Success
• Learn to Expect the Unexpected in Global Retail Expansion
• VIDEO: Stop the Madness: A Recipe to Jump-Start the Global Economy
• The Book Corner
• Video Library
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2011 Volume 14 Issue 3

• Editor’s Note
• Labor Pains: The Recovery of the U.S. Labor Market is about to be Pushed Back
• Creating Advocates: A Values-Oriented Approach to Developing Brand Loyalty
• Leveraging Action Learning as a Talent Management Strategy during Economic Uncertainty
• Protecting Descriptive Brands in Trademark and Trade Dress Law:
• VIDEO: Transforming the Relationship between Business and IT Executives
• The Book Corner

2011 Volume 14 Issue 2

• Editor’s Note: Finding Distinctiveness
• Secondary Meaning in Trademark and Trade Dress Law
• Financial Elements of Business Resilience
• Positive Organizational Scholarship and Practice: A Dynamic Duo
• VIDEO: Currency Wars, a Faculty Panel
• The Book Corner

2011 Volume 14 Issue 1

• Editor’s Note
• A Consequence Analysis that Needs to be Shared
• Family Business Succession
• The Quest for Distinctiveness in Trademark and Trade Dress Law
• Self-Organizing Conversation as an Invitation to Serendipity
• The ABC’s of Effective Feedback
• “Spiritual Capital and Virtuous Business Leadership” with Yale’s Ted Malloch
• “The Role of the CIO” with Harvey Koeppel
• The Book Corner

2010 Volume 13 Issue 4

• Attn: The Corner Office – Why U.S. Firms Should Pay Special Dividends Before Year-End 2010
• The Charisma of Twitter
• Lessons from the New Dodd-Frank Financial Regulatory Reform Law
• The Changing Role of the Residential Real Estate Broker
• 2010 Student Paper Winner: Using Social Media to Grow Your Business
• Editor’s Note: New Look, New Name, Still Great Content
• What to Do when Traditional Diversification Strategies Fail – Revisited
• Great Leaders are Great Decision-Makers
• The Four Levels of Innovation
• The Book Corner

2010 Volume 13 Issue 3

• The Spoiled American
• Choosing Your Negotiation Site
• Editorial: Systems Thinking
• Improvisation as a Way of Dealing with Ambiguity and Complexity
• Economic Recovery Gaining Traction
• The Book Corner
• City National Bank’s Robert Iritani Discusses the Future of Financial Management
• An Interview with Clean Tech Start-up Advisor Susanna Kass
• Servanthood Leadership

2010 Volume 13 Issue 2

• Carl Schramm Talks Expeditionary Economics
• Highly Effective Technical Personnel Strategies
• Real Options: The Value Added through Optimal Decision Making
• 10 Lessons for Entrepreneurs
• Utilizing Business Service Management Concepts to Improve Healthcare Information Services
• Editor’s Note
• Strategies for Leading through Times of Change
• Editorial: Will commercial real estate will follow in the footsteps of the residential property market?
• The Book Corner

2010 Volume 13 Issue 1

• Six Steps for Confronting the Emerging Leadership Succession Crisis
• Interview with Robert Eckert, Chairman of the Board and CEO of Mattel, Incorporated
• Political Connections: The Missing Dimension in Leadership
• How Coach, H-P, Zara, and Ford Profited from a Comprehensive Application of Market Orientation
• Three Ways Larger Monitors Can Improve Productivity
• The Role of Finance in the Strategic-Planning and Decision-Making Process
• Editorial: Is Robotics America’s Ticket to Continued Global Competitiveness?
• The Power of Collective Wisdom and the Trap of Collective Folly By Alan Briskin, Sheryl Erickson, John Ott, and Tom Callanan
• The Book Corner

2009 Volume 12 Issue 4

• Women, the Recession, and the Impending Economic Recovery
• The Power of Sharing in an Uncertain World
• How to Communicate Change to Employees
• Five Tactics to Create a Sustainable Restaurant Business
• IT Solutions for SMBs in an Economic Downturn
• What’s Next, Hollywood?
• Eight Key Attributes of Effective Leaders
• What to Do When Traditional Diversification Strategies Fail
• Video Interview on Corporate Social Responsiblitiy with Golden State Foods

2009 Volume 12 Issue 3

• Offshoring May Slow Impending U.S. Economic Recovery
• In Memory of Luis Villalobos
• IT Outsourcing: China Grasps for the Lead
• The Buffett Approach to Valuing Stocks
• Audio Interview with McKesson U.S. Pharmaceutical President John Figueroa
• Editorial: E-Learning is Green Learning
• The Book Corner

2009 Volume 12 Issue 2

• The Root Causes of Unethical Behavior
• Price Fixing and Minimum Resale Price Restrictions Are Two Different Animals
• Investing for Income in a Down Economy
• What Determines Which Businesses Win and Which Lose?
• Editorial: Writing a Business Plan to Attract Investors
• What’s Next LA: The Road to Economic Recovery
• Owner-Occupied Commercial Real Estate for the Entrepreneur
• The Winner’s Curse and Optimal Auction Bidding Strategies
• The Book Corner

2009 Volume 12 Issue 1

• Private vs. Public Real Estate Markets
• More Than Money: Interview with social entrepreneur Mark Albion
• The Successful Expatriate Leader in China
• Recognizing Organizational Culture in Managing Change
• Editorial: Taking Advantage of California’s Retirees to Help Close the Budget Gap
• Believe It: Complaints Are Gifts
• Active Alpha Portfolio Management
• Active Alpha Portfolio Management: Appendix A
• Active Alpha Portfolio Management: Appendix B
• The Book Corner

2008 Volume 11 Issue 4

• Best Practices for Headcount Reporting
• 2008 Graziadio School Student Paper Competition – How Intercultural Competence Drives Success in Global Virtual Teams
• Discovering Leadership Potential
• Discovering Leadership Potential – Evaluation Guidelines
• Corporate Governance, SOX, and the Business Judgment Rule
• What Will The International Financial Reporting Standards (IFRS) Mean to Businesses and Investors?
• Who are Fannie Mae and Freddie Mac?
• Crisis in America: A Nation at Risk
• The End of the Beginning for the Global Credit Crisis
• The Book Corner
• All IFRS-Compliant Statements Are Not Equal

2008 Volume 11 Issue 3

• The Book Corner
• IT-Enabled Information Transparency: A Strategic Approach
• Editor’s Note: The Top 10 Embracements for Difficult Economic Times
• Servicing the Software Industry (SaaS)
• Where Do Older Workers Go?
• Creating Wealth in Low Income Communities
• Supplier Diversity and Competitive Advantage: New Opportunities in Emerging Domestic Markets
• The Last 100 Feet of the Supply Chain
• America’s Financial Crisis

2008 Volume 11 Issue 2

• The Tie-In Decision
• The Trybaby Syndrome
• California Greening: Boom or Bust?
• High CEO Pay Could Draw Renewed Attention in Election Year
• Empowering Employees to Success
• Commercial Banking and Treasury Management in Mexico

2008 Volume 11 Issue 1

• Venture Capital Audio Interview
• Learning to Love Financial Market Barbarians
• The Top 10 U.S. Economic Issues to Monitor
• Putting Performance and Happiness Together in the Workplace
• In Memory of Robert Hockenberg
• Harassment Prevention Training 2008
• Editorial: No Child Left Behind-A Blueprint for Success
• A Class with Drucker by William A. Cohen
• The Book Corner
• Is Managed Futures an Asset Class?

2007 Volume 10 Issue 4

• Organizational Design and Implementation
• Managing the Critical Role of the Warehouse Supervisor
• Editor’s Note
• Creating a Community in Southern California that Values Sharing Knowledge
• The Book Corner
• Commercial Banking in the U.S. Versus Canada

2007 Volume 10 Issue 3

• Developing a Barometer for Workplace Attitude (WPA)
• The Employers’ Legal Obligations to Employees in the Military
• Employee Incentives
• Will the Sub-Prime Meltdown Burst the Housing Bubble?
• Strategic Leadership – Part Two
• Editor’s Note
• Assertive Performance Feedback
• To Tell or Not to Tell?
• The Book Corner

2007 Volume 10 Issue 2

• The Trader Joe’s Experience
• Strategic Leadership
• Managing Organizational Knowledge
• The Family-Owned Business
• Editor’s Note
• Emotional Dynamism: Playing the Music of Leadership
• Benefits of International Portfolio Diversification
• Aligning Business with a Value Statement
• The Book Corner

2007 Volume 10 Issue 1

• The Death of Time and Distance
• The Moral and Financial Conflict of Socially Responsible Investing
• What You Need to Know about Labor Shortages
• Women Entrepreneurship
• SEC Quest to Regulate Hedge Funds Hits Speed Bump
• The Book Corner

2006 Volume 9 Issue 4

• Seasonality and the Stock Market
• Airline Industry Key Success Factors
• Seven Neurotic Styles of Management
• IT in Healthcare
• Wings of the Great Northwest
• Gratitude at Work
• Editor’s Note
• The Book Corner
• Alternative Dispute Resolution

2006 Volume 9 Issue 3

• Making Marketing Accountable
• Conversations about Conscientious Capitalism
• Gen Y and Organizational Life
• Class Action Shareholder Suits Face Legal Setbacks
• The Book Corner
• Achieving Corporate Success and Maximized Value
• New: GBR Blog Videos

2006 Volume 9 Issue 2

• Business Survival Skills
• Six Components of a Model for Workplace Spirituality
• HR’s Strategic Partnership with Line Management
• The Book Corner
• Obesity, Social Responsibility, and Economic Value
• Graziadio Faculty Discuss Ethics

2006 Volume 9 Issue 1

• A Winning Tool to Manage Price: The Pricing Checklist
• Update: The Price of Oil
• Mapping IT Resources for Successful Implementations
• Is the Real Estate Market a House of Cards?
• Whither Now Dow?
• The Book Corner

2005 Volume 8 Issue 4

• Whistleblowers
• Editorial: Does a Non-Public Business Need SOX?
• IT Matters
• A New Imperative for Management: Sexual Harassment Training
• The Company Director’s Role In Company Growth
• Editor’s Note
• The Book Corner
• Fair Trade or Strategic Concern: The Unocal War

2005 Volume 8 Issue 3

• The IT Governance Road Map
• Avoiding Ethical Misconduct Disasters
• The Positive Psychology Approach to Goal Management
• Antitrust Law in the European Union
• Editor’s Note
• The Book Corner
• D & O Policies: Greater Risks Less Coverage
• A Blueprint for Change: Appreciative Inquiry

2005 Volume 8 Issue 2

• Connecting Enterprise Information and People in a Web World
• The Leader’s Role in Strategy
• The Practical Nuances of Leadership
• Editor’s Note
• Corruption Across Borders
• Resolving Intra-Organization Conflicts
• An Uphill Battle
• Leading and Managing Change
• The Book Corner

2005 Volume 8 Issue 1

• The Link Between Price and Profit Margin in a Global Market
• IT MATTERS
• The Impact of Empowered Employees on Corporate Value
• What You Need to Know about Attorneys’ Fees
• Editor’s Note – Phishing
• The Book Corner
• Strengthening Value-Centered Ethics (Part 3)
• Will Your Company’s Electronic Records Storage Withstand Legal Scrutiny? – Graziadio Business Review
• Conversation on Leadership with Jeff Shell

2004 Volume 7 Issue 3

• Litigate or Arbitrate?
• Presidential Elections and Stock Market Cycles
• Businesspersons Beware: Lying is a Crime
• Strengthening Value-Centered Ethics (Part 2)
• Attempting to Control Health Care Costs – Again
• Editor’s Note
• The Crude Facts About the Price of Oil
• Conversation with Stephen Baum
• The Book Corner
• The Uncertain World of Trademark Dilution

2004 Volume 7 Issue 2

• Does Corporate Social Responsibility Pay Off
• Strengthening Values Centered Leadership
• The Twin Deficits
• GBR Conversation with Robert Miller
• The Book Corner
• From Michelangelo to the Modern Boardroom
• Preparing for a Future Labor Shortage

2004 Volume 7 Issue 1

• Slowing Runaway Juries
• Merger and Acquisition Strategies
• Slips, Trips, and Falls
• Using Conflict to Your Advantage
• Wired
• Editorial – Don’t Panic!
• Seek and You Might Find
• GBR Conversation with Tom Ross
• The Dollar vs. the Euro
• The Book Corner

2003 Volume 6 Issue 4

• Negotiating Effectively
• Why Good Leaders Do Bad Things
• Editorial: Cybersatire
• Main Street and Hedging
• E-Business at the Graziadio Business Review
• What Stays and Who Pays?
• Inflation to Deflation and Back?
• Conversation with Betsy Bernard
• The Car Deal
• The Book Corner
• Using Dashboard Based Business Intelligence Systems

2003 Volume 6 Issue 3

• The Cost of Lost Data
• Consolidate All IT?
• Blowing the Whistle
• Creating and Sustaining an Ethical Workplace Culture
• Editorial – Onward and Upward?
• IT Matters: Portal Combat
• Facing Up to the Possibility of Deflation
• Dialogue With Four Executives

2003 Volume 6 Issue 2

• Hedging Strategies for Uncertain Times
• Do Not Call!*
• Improving R and D Performance Teamwork trumps solo endeavors
• Just-in-Time to Just-in-Case
• Increasing the Firm’s Strategic IQ
• Special Purpose Entities
• Shock and Awe
• IT Matters: Webhosting
• Conversation with Bert Boeckmann

2003 Volume 6 Issue 1

• Communicating Your Strategy
• Reforming Corporate America
• Recognize the True Cost of Compensation
• Learn from Experience
• Use Emotional Intelligence to Cope in Tough Times
• Conversation with Lacy Edwards of Evoke Software
• Editorial
• Predicting Bankruptcy in the WorldCom Age

2002 Volume 5 Issue 4

• Build Value in a Small Business
• Protect Your Trade Secrets
• Managing in an Era of Multiple Cultures
• Pros and Cons of Expensing Stock Options
• IT Matters: Web Services May Bridge the Great Culture Gap
• Editor’s Note
• Conversation with Paul Orfalea
• Calculating the Strategic Value of Customer Satisfaction

2002 Volume 5 Issue 3

• Encourage Your Employees to Play
• Managerial Leadership at Twelve O’Clock
• Remembering George L. Graziadio
• Editor’s Note: Bad Boys in the Board Room
• Who’s Driving American Firms?
• Supreme Court Sides With Business
• Using Asset Allocation Strategies to Recover from a Bear Hug
• Mediate, Arbitrate or Litigate?
• IT MATTERS: The Wonderful World of the Wireless Web

2002 Volume 5 Issue 2

• Will China Float the Yuan?
• Does Market Efficiency Trump Behavioral Bias in Finance Decisions?
• Making Mergers a Growth Strategy
• Sealing Cracks in the Capital Markets
• Artificial Intelligence Techniques Enhance Business Forecasts
• Editor’s Note: Weapons of Mass Disruption
• E-Commerce Reboots
• IT MATTERS: Web Services Prevail Despite Travail
• Go Directly to Jail?
• GBR CONVERSATION With John Shields

2002 Volume 5 Issue 1

• Build a Culture of Value Creation
• Choose Tomorrow’s Leaders Today
• Small Firms Keep R&D Vibrant
• Teams Use IT to Manage Client Impressions
• Putting Spirituality to Work
• IT MATTERS: Fifty Years and Counting
• Defining Disability Under the ADA
• GBR Conversation With Joe Rokus
• Editor’s Note: Decisions, Decisions, Decisions

2001 Volume 4 Issue 4

• Gender Impacts Virtual Work Teams
• Doing Business in a Volatile World
• The Strategic Downside of Downsizing
• Editor’s Note: Corporate Citizenship in the Wake of September 11!
• The Economic Downturn is No Surprise
• IT MATTERS: ROI for Tech Deployments in the Downturn
• Supreme Court Faces Key Business Cases
• GBR Conversation with Michael Josephson
• Are Workplace Bullies Sabotaging Your Ability to Compete?

2001 Volume 4 Issue 3

• Suddenly Unemployed?
• Too Late for an IPO?
• Electricity Price Gouging in California?
• Editor’s Note: Surf’s Up!
• The Fine Art of Delegation
• Waiting Games People Play
• Business at the Bar
• GBR Conversation with Senator Sandra Bowen

2001 Volume 4 Issue 2

• Knowledge Management and Business Portals
• Trust as a Competitive Advantage
• Is Price Everything?
• Editor’s Note: A Quarter Without Quarter
• Has the Dow Really Escaped the Bear?
• Dot.Gone
• IT MATTERS: E-Business is Definitely an E-Ticket Ride!
• Downsizing with Dignity
• GBR Conversation Mitchell J. Held
• The California Electricity Crisis

2001 Volume 4 Issue 1

• Repetition Leads To Innovation
• What’s the Problem?
• Editor’s Note: Quakes, Flakes, and Double Takes
• IT MATTERS: CRM Solution Seekers Beware!!!!
• Language, Culture and Global Business
• GBR Conversation Dr. Clyde Oden Jr.
• Personality Traits and Workplace Culture
• Who Wants to Lose a Million?
• The Power of Performance Profiling

2000 Volume 3 Issue 4

• Building Wealth
• How Small Firms Plan to Grow
• Using Internet Portals to Manage the Information Deluge
• Editor’s Note: Messy Brains and Global Opportunities
• SEC Requires Fair Disclosure
• IT MATTERS: MP3.com Completes Settlements
• GBR Conversation with Boyd Clarke
• Planning in a Complex World
• Business Be Advised!

2000 Volume 3 Issue 3

• Do Japan’s High Tech Failures Open Doors for Western Firms?
• Managing Earnings … or Cooking the Books?
• The Battle Over Merger Accounting – Graziadio Business Review
• GBR Conversation with senior economist
• Editor’s Note: Friends, Romans & Countrymen…
• What Directors Need to Know
• Still Thinking of Doing an IPO?

2000 Volume 3 Issue 2

• Managing Innovation through Corporate Venturing
• The Death of the Sales Force
• Thinking of Doing an IPO?
• Serving Each Other on the Inside
• Editor’s Note: Screaming Into the Future!
• GBR Conversation with Stephen J. Goldman
• Will Marketers Survive the Information Age?

2000 Volume 3 Issue 1

• Re-Assessing the Health of the Asian Tigers
• Knowledge Management and the Internet
• The Learning Organization in Practice
• Economic Forecasting
• Editor’s Note: A Short Hello!
• Are You Ready for E-Commerce?
• E-Business: The New Management Challenge
• GBR Conversation with Raytheon’s Daniel Burhnam
• The Bull Market’s Flawed Foundation

1999 Volume 2 Issue 4

• The Electric Day Trader and Ruin
• Teambuilding for Competitive Advantage
• Parable of the Commons
• Preserve and Strengthen a Business Partnership
• Editor’s Note: Here to Be Thrilled!
• GBR Conversation with Mike Roberts
• Telecommuting… Out of Sight, Out of Mind?
• Balancing Act for Employers in Today’s Labor Market
• Editor’s Note: Too Much Fun!

1999 Volume 2 Issue 3

• How Gerber Used a Decision Tree in Strategic Decision-Making
• Customer Satisfaction Measurement
• Get Your Message Across!
• E-Commerce & Taxation
• GBR Conversation with Dr. Gary Hamel
• To Join or Not To Join..?
• T.I.P.S.

1999 Volume 2 Issue 2

• Defamation Vs. Negligent Referral
• Maximize Business Achievement
• Preserving Family & Business Assets – Graziadio Business Review
• Knowledge is Power…
• Editor’s Note: Welcome to the Graziadio Business Review
• E-Commerce & Taxation
• GBR Conversation with Wayne “Buz” Knyal
• Cultivating the Customer Asset
• Decision-Making in a Global Environment

1999 Volume 2 Issue 1

• Business and Universities Moving to Collaborative Technologies
• Tips for Reducing Executive Stress
• Russia at the Crossroads
• Editor’s Note: Volume I, Issue 4
• GBR Case Study
• Launching an Effective Citizen Advisory Panel

1998 Volume 1 Issue 3

• Retirement Call to Action
• The European Directive On Data Privacy
• Editor’s Note: Welcome to the GBR, Volume I, Issue 3
• Debt Tied to Lower Firm Performance
• A conversation with Angelo Mozilo
• Boosting Country Club Memberships With Innovative Marketing and Pricing Concepts

1998 Volume 1 Issue 2

• Management Skills for the 21st Century
• Middlaning
• Editor’s Note: Welcome to the GBR, Volume I, Issue 2
• A conversation with Jeffrey Rigsby
• Cultural Insights on Doing Business in China
• When Worlds Collide

1998 Volume 1 Issue 1

• Editor’s Note: Welcome to the GBR
• Guide to Personal Investment Software
• Southeast Asia: Crisis To Recovery
• Growth Strategies for High Tech Firms
• A conversation with George L. Graziadio
• The Human Realities of Corporate Downsizing
• AB Corporation Case Study

Family Business Succession

Passing a business to the next generation requires the appropriate legal tools and a well-designed succession plan.

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“But Dad, you didn’t tell me I had to be at work by 8 a.m.! By the way, is six weeks vacation too much? Oh, and did I mention that my car allowance needs to be at least $1,500 per month? And just to be clear, I don’t think my brother and sister should work in the business.”

Many business owners would like to pass their business to the next generation. They would also like to make sure they have adequate funds to enjoy their retirement years. This concern, along with demands similar to those in the first paragraph, are some of the reasons that the parents oftentimes end up selling to an unrelated third party. Transferring the business to the next generation only works if that generation has the desire to carry on the business. The heirs may want to sell the business as much as the parents. They may realize that the optimum value can be obtained while the parents are there to transition to a new buyer. The heirs may also not want to risk the fortunes of the business and their financial future on the untested management of the next generation.

Passing businesses to the next generation, however, is done successfully on a regular basis. Getting there involves overcoming a lot of obstacles. A lack of planning, poor communication, and insufficient “cash” are three critical obstacles. If there is no “cash,” then something else has to be added to the formula to get the results that the parents and the children seek to obtain. This article will address these issues by focusing on two key aspects of business succession planning: 1) Parallel planning for both the family and the business in succession matters; and 2) Corporate legal tools that can create a workable formula for the transfer of the business to future generations.

Family Business Continuity Tools in Business Succession

Around the world, these words resonate with business owners: “Wealth doesn’t last beyond three generations.” This is the most succinct statement of a fear that can hang like a dark cloud over the otherwise remarkable success of many entrepreneurs and their families. Whether it is an operating business or portfolio of invested assets that is passed along to heirs, the “three generation rule” can apply. But it is not a law of nature or some other incontestable force to which all must yield. Many families have successfully passed along thriving businesses for many generations, in the process creating new wealth and carrying on the legacy of the founder.

The difference between success and failure is often due to planning on both the business and family fronts. This parallel planning process should be holistic in nature, including family decision making, ownership preparation, leadership development, sound financial planning, and legal structures that allow for the growth of both family and business. Principally, five elements are needed for successful succession of a family business.

• Business Strategy Plan. If a business has been treated as a “cash cow” and deprived of reinvestment and strategic realignment at critical points, it may need to be sold while there is value remaining before it reaches the point of failure. It is critical that a family-run business is properly nurtured to make sure there is a successful business to transfer to the next generation. Making the strategic commitment to build toward succession should be done well in advance. This commitment should be reflected in a statement of management philosophy and long-term goals that create a compelling “Vision Statement” for the business. This vision can inform all elements of the strategy of the business and shape plans to invest in its future.

• Governance. In order to accomplish the goals set forth in the Vision Statement, a governance strategy should be implemented that represents the interests of all owners. Adult children are often willing to let their mother or father make all the decisions regarding the business they founded even after there has been significant gifting or other forms of share distribution to make the children the actual owners of the enterprise. However, when Mom or Dad leave the business, this deference in decision making is generally not extended to a sibling, cousin, aunt, or uncle. In addition, the senior generation may not be willing to completely turn over decision making to their successors if their lifestyle in retirement depends upon a regular payment from the profits of the business. Providing for an independent retirement for the senior generation is a key to successful transitions in decision making and governance.

• Creating the Right Family Dynamics. Sending the right messages is critical to the succession plan. Positive action should be taken early in the process to orchestrate and encourage the participation of future generations both as managers and owners of the business. On the other hand, parents should be open to alternative career choices and opportunities for their children to consider and not try to force them to go into the business. It is difficult to inspire children to want to be part of the family business if the only knowledge they have is based upon overhearing discussions of the day’s business problems around the dinner table. Nor does aspiring to lead the family business seem to make much sense to the next generation if Mom or Dad never plans to retire. These and other messages, sometimes subtle and sometimes not, can derail the best financial, legal, and business planning. A statement of vision and values for the family and business can prove to be a positive message that will inspire generations to come.

• Family Values and Cohesiveness. Creating a separate vision statement that builds family commitment and readiness for succession is also critical. This statement should be developed around the core family values that have made the family successful and that can become a lasting pattern for success in the future. Core values of a family inform the development of a philosophy about why it is important to retain ownership of a business in the family.  From this philosophy, comes the Family Vision Statement, which can become a guiding beacon for success in the future.

• Great Plans and Even Greater Communication. Plans that provide for the development of effective owners, whether active in the business or not, can provide for the “patient capital” that will allow a business and family to prosper for many generations. These plans will serve as guides for the effective financial and legal planning necessary to implement a succession plan. The best laid plans, however, will fail if not properly communicated to all the family members. Therein lies the greatest value of the planning process—the building and continuation of strong family relationships. It may be wise to enlist the help of  a mature, experienced family business consultant, who can provide the buffer and the clarity that are essential in the communication process to promote family harmony and achieve a successful business transition.

Corporate Tools Available in Business Succession Planning

There are many corporate/business law planning alternatives that can serve as the “frame” upon which to build and execute a successful family business succession structure. The following is a brief explanation of some of the “tools” that can be used to create the frame that will best suit the structure of each business succession.

• Voting and Non-Voting Stock. Children not involved in the business can be given non-voting stock so that the active owners can control the business operations. Certain actions taken by the active owners (and controlling board members or managers) could require a “super majority” vote. The non-active owners can control key decisions by being able to participate in a “super majority” vote on such matters as: 1) salaries of key employees (family members particularly); 2) issuance of additional ownership interests; 3) encumbrance of a significant portion of company assets; 4) material asset acquisitions; and 5) sale of a material portion of the company or its assets. Family harmony can be threatened if one group of heirs feels they have too little say in what is being done with their “patient capital.”

• Ownership Preferences. In the case of a corporation, preferred stock may be used, and in the case of an LLC or partnership, preferences can be built into the operating or partnership agreement. These preferences can provide passive owners with priority returns from operations and a first priority upon liquidation or sale. These rights will give the inactive owner(s) security that the interest they started with upon transfer to their generation will not diminish in value and, if it does, the active owners will not get anything more than they will receive. There are many variations of how these preferences can work. These techniques can be referred to as “risk/reward locks.” The key is to incentivize management to run the business day-to-day in the best interest of all owners without undue interference by inactive owners.

• Separating the Business or its Assets. If the business can be separated into two or more operating units (and meet the IRS requirements for doing so without triggering onerous tax obligations), one or more separate operating units can be put into the hands of specified children and/or sold to an unrelated third party. It may also be possible to spin out some of the assets from the business that can then either be given directly to nonparticipating children or sold for the benefit of those children. There are a number of reorganization techniques that can be used to accomplish the family’s goals. A partial sale and succession plan may help solve any liquidity problem by generating cash that can be given to the parents, thereby reducing the risk that they will not be paid completely for all of their interest in the business sold to their heirs.

Care must be taken not to exacerbate or encourage family conflict with such structures. For instance, if one set of heirs has the voting control over an operating business and another group has voting control over the buildings, land, and other assets needed to operate the business, vastly different priorities may emerge over time. One group may depend upon a salary income from continued operation of the business, while others may want to sell underlying real estate or other assets so that the proceeds are available for use or reinvestment. There is also the almost certain principal that “equal” businesses operations, once separated, will not perform equally due to many factors outside of management’s control. This can leave one group of heirs significantly wealthier than the other over time and may result in a perceived lack of fairness.

• Trust with a Little and then with a Lot. An incremental approach to the succession of the business will give the parents the ability to see how the children handle limited ownership and responsibility before putting everything in their hands. One way to do this is by licensing certain technology, products, or services to another entity owned by the child. Failure to do all the things necessary to develop, sell, and create profits based on this license may be an indicator of future performance. If things do not go well, the parents may want to reconsider passing the business to children who prove not to be responsible owner/operators.

• Buy-Sell Agreements. Buy-sell agreements are very good tools to control ownership of a company between unrelated parties, but they can lead to some serious traps in family business succession planning. A buy-sell agreement is designed to keep ownership out of the hands of either someone you do not know, or someone you know and who you do not want to have as a co-owner/partner. Using a standard buy-sell agreement with family members will almost always result in unintended consequences, since a buy-sell agreement will typically not address the other 90 percent of the issues that should be addressed when transferring a business to family members. Careful analysis should be undertaken before providing rights and obligations to family members who, regardless of their current relationships, may not see eye to eye in the future. Forced redemptions of stock could cause business cash flow problems and the inability to sell could cause significant family financial conflicts and even litigation.

• Life Insurance. Life insurance funding can be useful if parents and children are both involved in the business; however, care should be taken in structuring the legal and beneficial ownership of those policies. If, following the death of one of the family members, a policy is transferred to another family member or owner, there could be a “transfer for value” and the future proceeds (minus any basis and future premiums) would be subject to ordinary income tax. A “transfer for value” occurs not just where there is compensation exchanging hands, but where there is a change in rights or obligations of the parties. For example, if there are three owners with policies on each of their lives held in an escrow or trust, when one owner dies, if the other two policies remain in place and continue to be held in trust, there will be a deemed “transfer for value” since there is a mutuality of obligation arising out of the agreement to continue the policies for the benefit of the surviving shareholders. If this sounds complicated, it is. Competent tax counsel should be employed to avoid these problems. Life insurance ownership can also be structured to minimize and/or to avoid future estate tax.

• Form of Entity. Careful consideration should be given to the form of entity in which a family business is held. Especially in the case of companies which an entrepreneur has built “from the ground up,” the entity type and its governance might be outdated or even downright problematic. Varying rights and obligations are attached to “C” corporations, “S” corporations, LLCs, and partnerships. LLC operating agreements and limited partnership agreements both provide an open design format with a great deal of latitude for addressing many of the management and ownership issues discussed above. LLCs and limited partnerships also may provide for better tax planning alternatives.

• Debt Instruments and Security. Since children may not have the “cash” to buy out their parents, the succession plan will generally include a debt instrument and usually something to secure that instrument. One common problem is that the business will usually have a primary lender so any indebtedness to the parents would have to be subordinated to the rights of that lender. Subordination substantially reduces the quality of any security provided by the children in the business. Protections can be built into the debt obligation to the parents by providing the parents with many of the positive and negative covenants contained in a bank financing with clear and definitive rights upon default. These protections may protect the parents by allowing them to regain control or make changes while the business still has significant value. Outside collateral could also be provided by the children, but not many parents are willing to take their child’s “house” if they default. The variations on loan documents and security instruments are almost infinite and should be created with the input of competent legal counsel and financial advisors.

In spite of all the potential issues and pitfalls, there are many situations where businesses have been successfully transferred to successive generations. It is very understandable, after all the hard work and risks taken by the parents to start and establish a successful business, that they would like to see their children continue their legacy. Parents who do want that legacy to continue should make sure they have all the necessary tools at their disposal, adopt a well-designed succession plan and undertake all the necessary steps required to implement that plan.

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