Strategy for Armellini Ice Cream and Coffee Chain - Case Study Example

Case Study: Armellini Ice Cream and Coffee Chain Background Armellini is a family-owned company that operates Italian retail café-restaurants. Founded after World War II, the company grew to about 100 outlets in Europe, Australia and Asia, and was family operated until a few years ago when it hired its first chief executive from outside. Recently, growth stalled, a variety of operational problems emerged, and financial performance deteriorated greatly: in 2006 compared to 2001, revenues declined 27% to €45 million, operating profit declined 31% to less than €14 million, and annual shareholders’ return dropped from 26% to 13%. The firm has asked for my advice regarding possible growth strategies other than franchising. In evaluating possible strategies, I evaluate Armellini’s growth objectives; analyze Armellini’s internal strengths and weaknesses and its external opportunities and threats; develop relevant conclusions; and then offer specific recommendations. Armellini’s Growth Objectives By definition, a strategy is an action plan to achieve a certain objective. So in order to suggest possible growth strategies, I must understand the firm’s objectives, especially those that have been agreed to between Armellini ownership (Armellini family) and top management (Helen Patterson). The case mentions only three overall business objectives that have been expressly agreed to: Address issues of brand, product range and geographic scope. Bring Armellini’s traditional values in tune with modern day realities while preserving the friendliness, family atmosphere, and “style and flair” unique to the Armellini business. Make Armellini a truly “glocal” (global and local) organization. These objectives present several problems in fashioning appropriate growth strategies. First, only the third objective definitively addresses Armellini’s business growth; the others may affect the nature and quality of growth, but that is not entirely clear. Next, there are no financial objectives mentioned despite the recent precipitous decline in financial performance. Third, each objective is extremely vague; in order to serve as a guide to action plans, well-developed objectives should be specific, measurable, attainable, realistic and timely (SMART). Finally, these objectives ignore two critical standards for good business objectives: that they aim to create sustainable competitive advantage and build value for business owners. When crafted well, such objectives would reinforce each other, with competitive advantage leading to improved financial performance and value, and improved financial performance providing financial resources to invest in growth opportunities that promote competitive advantage. In light of these problems, in the following analysis I will also consider other growth objectives that would be appropriate to recommend to Armellini along with recommended growth strategies. These other objectives may be entirely new or revised versions of the above three. Armellini’s Internal Strengths and Weaknesses Armellini retains several strengths that, although recently diminished, could be helpful in formulating and achieving growth objectives and strategies: Established customer base across important geographic markets. A brand that is recognized by the target customer segment, is differentiated compared to competition, and communicates a positive message. Physical infrastructure and supply chain relationships to serve large, diverse geographic markets. Selected ownership, management and staff familiar with Armellini’s previously successful business strategies and management practices. Financial capacity to selectively invest in new strategic initiatives. However, Armellini has several internal weaknesses that limit its ability to undertake and achieve major growth initiatives. The major weakness is that Ms. Patterson is a poor manager and leader. The case information does not make clear when Ms. Patterson was hired or the connection between her efforts and the 2001-2006 decline in Armellini’s operational and financial performance. Nevertheless, although “committed to expansion of the business” she failed to expand both the company’s product line and geographic scope. Ms. Patterson eliminated or weakened certain highly successful management practices (e.g., operational audits, employee training, employee rewards and recognition); did not stop the erosion of the chain’s successful “Italian flair and charm” image; allowed inconsistent “entrepreneurial” efforts by local café managers to change the product offering and interior décor; was losing support of ownership; and so on. In fact, it appears her only real accomplishment was improving the financial reporting system, which is not a strategically fundamental issue. This track record, along with Ms. Patterson’s lack of previous operational and retail restaurant industry experience, makes it likely she cannot lead a successful turnaround and future growth. Armellini has other organizational weaknesses that will limit its ability to undertake and achieve major growth initiatives, including: Hands-off ownership that allowed the business to deteriorate for some time before pushing for changes and which also hired Ms. Patterson. Apparent lack of strong next-tier senior management that might support or take over from Ms. Patterson. Increasing inexperience of field personnel due to poor training and turnover. Armellini’s other major weakness is an apparent lack of financial management skill, despite Ms. Patterson’s background. This is reflected in the following problems: In the face of the escalating price of Brazilian coffee beans, there is no indication of attempts at creative contracts with current suppliers, hedging against unfavorable trends in the Brazilian Real, or search for more affordable substitutes from other countries. In 2006 compared to 2001, Inventory value increased by 78% despite revenues decreasing by 27%. Unless the Inventory value is entirely a result of price escalation (e.g., coffee beans), this suggests poor financial planning and control. The €20 million variable rate loan was taken out in 2004. Even though interest rates were low then, it is likely that Armellini’s operational and financial performance was at least starting to weaken, which should have raised concerns about taking out the loan at all or taking out such a large loan. Moreover, there is no suggestion that management recognizes, or is taking steps to deal with, the threat of rate increases. Although dividends paid out in 2006 were lower than in 2001, the payout ratio to after-tax profit remained the same at 40%. There is no suggestion that management has considered a more aggressive effort to conserve cash in the face of the decline of the business and the likely need for growth initiatives that will require additional investment. In sum, although Armellini still has certain operational strengths that a growth strategy can build on, the company has serious leadership, organizational and financial weaknesses that will limit its ability to develop and execute growth strategies. Armellini’s External Opportunities and Threats Armellini has always operated in the café niche segment of the restaurant market even as it has expanded its chain within Europe and in selected other countries. Its universe of growth opportunities includes (a) generating more revenues and income within its existing chain, (b) expanding the range of products it sells, and (c) expanding the range of markets and customers that it serves. Given Armellini’s present modest position in a narrow niche of the massive, worldwide restaurant industry, (a) and (b) probably offer all the potential it could possibly handle. In assessing Armellini’s growth opportunities, risks of alternative strategies need to be considered. To this end, the matrix on the next page illustrates a helpful way of assessing risk based on the extent to which new products and new markets/customers are related to a firm’s current products and markets/customers. In general, the more closely related a new product is to current products, the easier and less risky it is for a firm to pursue; and the same concept applies to markets/customers. The arrows illustrate increasing difficulty and risk of pursuing different growth strategies. Clearly, the lowest risk for Armellini is to generate more growth within its existing product and market/customer base. Next least risky would be to pursue (a) new products for its current customer/market and (b) new markets/customers for its current products, both of which the company has successfully done in the past. Armellini’s highest risk is to pursue growth by taking on entirely new products or entirely new markets/customers. Put in other terms, in pursuing growth, Armellini’s least risky integration strategy is horizontal and its least risky diversification strategies are concentric and horizontal. The major external threat that Armellini faces is the highly competitive nature of the restaurant industry. Another potential threat is the industry’s general trend toward consolidation, but this tends to create large firms that are less adept in competing in narrow niches. Conclusions The foregoing analysis suggests four major conclusions regarding Armellini’s growth strategy: Armellini’s existing, core business is its most important asset in formulating growth strategies because it has been based on differentiated competitive advantage and increasing shareholder value. Unless Armellini recovers its strength in this core business, it is unlikely to have the strategic strength or financial resources to pursue new opportunities. The experience of the Tanjong Pangar unit suggests ways this might be profitably done. If strengthened, this core might be expanded to additional geographic markets. Armellini does not have the strategic, management or financial strength to pursue growth strategies beyond adding related products for current markets/customers. The experience of Silvia Alonso of the Chelsea unit suggests ways this might be profitably done. If Armellini is not successful in the relatively short term in strengthening its core business and achieving at least modest growth in market position and shareholder value, shareholders may find better value opportunity by partnering with, or selling the business to, a competitor. Recommendations Based on the above findings and conclusions, I recommend the following growth strategies: First priority is to strengthen the existing chain of outlets. Management should consider a “triage” approach that divides those outlets into (a) those that are successful enough to not require management attention and additional resources; (b) those that are too weak to justify further investment and should be closed, at least temporarily; and (c) those that, with management time and resource investment, offer an opportunity to become value-adding contributors. This approach would optimize prudent funding, financial risk and management control. It would also provide a stronger platform for other growth strategies. Second priority is to strengthen the organization’s ability to pursue modest growth strategies based on new products for the current market/customer base and/or new geographic markets. To do this successfully probably first requires replacing Ms. Patterson and upgrading the rest of the leadership team, with primary attention to operational and financial management skills. It is contingent on some significant success in strengthening the existing chain of outlets in order to generate available funding and lower financial risks. In the event that satisfactory progress on the above two initiatives is not apparent over the next 6-12 months, ownership should consider exploring the costs and benefits of affiliating with a more successful competitor either by partnering or selling the company. A successful strategy could reduce/eliminate issues of funding, financial risk and management control. Read More