JOSEPH'S GOURMET PASTA AND SAUCES:ATA CROSSROADS oe Faro, founder and CEO of Joseph's Gourmet J , Massachusetts, had just come from a meeting with his top management team. It was already a very long day, something that Faro was accustomed to. Sales appeared to be recovering from a decline experienced during the first quarter of 2011, but there was disagreement as to the direction the firm should take and not even the slightest agreement on the cause of the downturn in sales. Faro wanted to come to a decision concerning the future direction of his company and do it reasonably quickly. He did not like the feeling of waiting for others to act and force a decision on him. As he prepared to leave for home, Faro wondered what his next moves should be: I want to spend more time with my wife and three kids, but I want to continue with this company. My dad is still working with his bakery, even expanding, slowly. I could go for- ever, but priorities change. It's been almost two decades at least for the way I run this .... It will run very well up to probably $50 million, but from $50 million to $70 million is where the challenges started to come. My facility is reaching 80-85 percent of current capacity, which is a sweet spot with good margins, but to expand, I need to be more strategic than operative, not just make next week work ... the strategic piece really suffers. JOSEPH'S HISTORY Faro founded Joseph's Gourmet Pasta and Sauces in 1995, shortly after graduating from college with a degree in business. The company initially produced traditional pasta as an extension of Faro's father's bakery business. Faro experienced little success selling this product for the restaurant industry until he met a chef at a restaurant north of Boston. The chef agreed to let Faro try to supply him with lobster-stuffed ravioli. Faro said, “The chef took pity on me. I had been trying to sell pasta to him for several months. I experimented for several days until I felt that I was able to replicate the chef's ravioli? The product was produced and frozen on the unused top floor of the bakery. The chef approved the product and agreed to purchase it from Joseph's. Faro offered a price that was lower than the cost for the chef to produce it himself. The chef was also happy to relieve himself of the tedious task of making the stuffed ravioli. Faro proceeded to sell his stuffed ravioli to a variety of restaurants, from Boston to southern New Hampshire, making the pasta in the morning and delivering it to his customers in the afternoon. The business grew steadily over the next two decades as he added new customers, restaurants, and an independent food distributor to handle his product. Faro noted that when he could no longer produce enough products to supply his customers, he began searching for ways to automate the production. He traveled to Italy to personally observe the best practices for making and producing pasta. In order to learn how to inject whole chunks of lobster or vegetables into his pastas, he visited Ben and Jerry's manufacturing plants to see how it injects whole chunks of chocolate, fruits, and other ingredients into its ice cream without melting or changing the ice cream's texture. He combined the best production practices and procedures of several other industries to develop his own automated manufacturing pro- cesses. In 1997, he hired his former college roommate, Dave Robinson, to help bolster sales. Robinson convinced Faro to expand into both restaurant-chain sales and wholesale clubs such as Costco and BJ's. Sales continued to increase throughout the next two decades. The continued growth caused the company to move, several times, into larger facili- ties. In the early years, growth was at least 25 percent per year. Joseph's continued to grow by expanding its product line, coverage in geographic area, and the types and numbers of customers served. In 2006, Faro approached the owner of his largest competitor (La Romagnola, a Florida-based firm) to see if an acquisition was a possibility. The owner, who had recently come to the United States from Germany, proposed a merger instead. Faro, however, felt the owners' management styles were too different to manage together. Two years later, with La Romagnola facing large losses, the owner approached Faro about selling La Romagnola. After serious negotiations, Faro acquired La Romagnola. The acquisition was primarily to secure distribution in the southeastern region of the United States and to gain access to a large national restaurant chain headquartered in Florida. The acquisition, along with internal organic growth, brought Joseph's sales to more than $34 million by the end of 2009. By the end of 2010, sales and profits had increased to more than $40.8 million and $6.2 million, respectively. Financial results for the years 2006-2010 are presented in Exhibit 2.1: JGP&S Income Statement and Exhibit 2.2: JGP&S Balance Sheet." Faro noted that the company had experienced 52 consecutive growth quarters through the end of 2010. January 2011 was different, however. He explained, “This one month, we were off 14 percent. We will be off about 6 percent for the quarter. The second quarter will be better. We made a decision to pull back. We were doing too many things." JOSEPH'S SPECIALTY PASTA MARKETS AND INNOVATION Joseph's produced an expansive line of high-end, frozen stuffed pasta as well as a smaller line of frozen ap- petizers. The products were frequently tailored to the individual needs of the customers. Although there was a “generic” line of products sold to small restaurants, chains, and wholesale clubs, many of the larger chains had insisted on a look that was unique to their restaurants. Faro had been able to design individual tools to stamp out the pasta shells to make them different for each of these large customers. He won over the customers by inviting them to his plant and demonstrating in a small laboratory how the product would be formed in a large-scale setting. Faro noted, “People ask why we spend so much on a pilot plant that doesn't add to capacity. When we bring in potential customers, they get sold by seeing us produce their product in that lab. We see this as one of the most profitable parts of the company. In the long run, we make more money out of the lab than anywhere else." By 2006, Joseph's had five chefs on staff performing R&D under the direction of Faro and his vice president of culinary and manufacturing operations. Faro designed the production process to mimic the way chefs made the products by hand. He explained, "We put real pieces of lobster in the ravioli. Actually, we are one of the largest processors of lobster in the country. We have our own processing plant in eastern Canada? Joseph's also employs stuffing consisting of ingredients other than lobster, including several types of cheese, chicken, mushrooms, shrimp, and other food products. The company also produces other forms of pasta shells in addition to ravioli. Joseph's initial market segment of small, local restaurants was served through independent regional food distributors. Faro and Robinson sought out one or two of the best distributors in every region they entered. They believed that though Joseph's had the best product on the market, convincing new restaurants to switch to them from their distributors was difficult. Robinson noted, “Distributors are very loyal to their suppliers, until these suppliers do something seriously wrong.” Although Joseph's had secured some suppliers outside of the East, other parts of the country were not well represented, including the West, Southwest, and Northwest. Large restaurant-chain accounts were developed and serviced by Joseph's in-house sales staff and man- aged by Robinson and Faro. These accounts were supplied either through the distributors or directly from the company facility. A third segment encompassed large warehouse clubs (including Bl’s and Costco) that were typically members-only facilities. A fourth segment, supermarket sales, was abandoned in late 2003, primarily because it had been an expensive division to enter and maintain due to its being a commodity- driven business. COMPETITION AND INDUSTRY TRENDS Joseph's main competition was composed of many local pasta makers who had revenues in the $1 million to $3 million range. Most of these competitors produced products manually for local markets. Some competitors b LOC = line of credit. Source: Joseph's Gourmet Pasta and Sauces, Financial Statements. 36 ACTING STRATEGICALLY, THINKING CRITICALLY: CONCEPTS, CASES, AND TOOLS FOR BUSINESS STUDENTS had expanded regionally to the $5 million to $7 million range by trying to replicate Joseph's product lines and technologies and by capturing some regional restaurant chains. These competitors, according to Faro, were also still producing manually, with labor costs anywhere from two to four times Joseph's. Joseph's salespeople closely tracked these rivals, regularly sending information back to Faro. Faro believed that though they were competing with Joseph's, they were also helping to spread the word about specialty pastas. He cautioned that these smaller firms were still trying to determine how Joseph's had managed to lower its costs by automating its manufacturing process. Some of Joseph's major customers were pressuring Faro to share his production methods with them, but he refused because he considered this his “magic sauce” and intellectual property. Protecting his technology from being copied by rivals, however, was becoming more and more difficult as Joseph's double-digit growth accelerated. The small companies were lacking in innovation (Faro believed that his company was at least a year ahead of them), but this gap was closing. Faro knew that one of his largest customers (who had asked Faro to provide a second source for Joseph's product) had teamed up with one of the smaller regional rivals to replace a significant amount of Joseph's product for the first quarter of 2011. Although none of the rest of his customers had followed this pattern, he noted that, even with Joseph's cost, some potential customers had expressed concerns about Joseph's being the sole source of his specialty pastas. Faro was being forced by some of the larger restaurant chains and wholesale clubs to lower Joseph's prices so they could increase their profit margins or lower their retail prices. Joseph's had managed to stay under the radar of big food processing companies, but this changed with the La Romagnola acquisition. Faro noted, “The big food companies now know that we are here, but so far they have not entered our markets.” These larger companies dominated the high-volume, lower-priced end of the frozen pasta market. They concentrated on lower-priced, mass-produced, and mass-marketed frozen foods and were unable to successfully enter the higher-quality, higher-priced specialty pasta segment. Faro also saw a change in consumer tastes toward more healthy food options, especially with emerging natural and organic specialty foods. NATURAL AND ORGANIC FUNCTIONAL FOODS By 2010, U.S. organic and natural food was a $26.7 billion industry. Natural food and functional food (herbal supplements, vitamin and energy drinks, and dietary remedies) were rapidly expanding from a few special- ized health-food stores to becoming a staple on supermarket and retailer shelves, as well as popular menu options in some restaurant chains. Standard and Poor's reported that more and more consumers expected their food and drink, in addition to tasting good, to be low in calories and offer other health benefits as well." In response to this trend, major food companies began to refocus their best product lines and acquire rec- ognized brands to encourage innovation in new areas for growth with higher profit margins. In 2010, the Organic Trade Association (OTA) reported that U.S. organic- and natural-foods sales grew 7.7 percent over 2009 and represented a 4 percent share of the $673 billion U.S. food industry. Beginning in 2002, the North American organic-food industry experienced major structural change. Large food companies who primarily mass-produced and mass-marketed their food products such as Nestlé, General Mills, Kraft, Dean, Pepsi, Kellogg's, and Cargill—were caught off guard by the rapid growth of the natural and organic markets." In 2010, с d e "US organic industry valued at nearly $29 billion in 2010; Organic Trade Association, accessed May 2012, http://www.organicnewsroom. com/2011/04/us_organic_industry_valued_at.html. "Organic Market Analysis," Organic Trade Association, accessed May 2012, http://www.ota.com/organic/mt/business.html. Graves, Tom and Easter Y. Kwon. "Foods & Nonalcoholic Beverages: Industry Survey." Standard & Poor's, June 9, 2011, http://www. standardandpoors.com. "Organic Market Analysis," Organic Trade Association, accessed May 2012, http://www.ota.com/organic/mt/business.html.; "Organic Production." The United States Department of Agriculture, http://www.ers.usda.gov/data/organic. "Organic World: Global Organic Farming Statistics and News" FiBL, accessed November 23, 2015, http://www.organic-world.net/index. html. f CRITICAL INQUIRY, BUSINESS MODEL EVALUATION, AND CASE STUDY 37 mass-market retailers (mainstream supermarkets, club/warehouse stores, and mass merchandisers) sold 54 percent of all organic food." NATURAL AND ORGANIC FUNCTIONAL FOODS By 2010, U.S. organic and natural food was a $26.7 billion industry. Natural food and functional food (herbal supplements, vitamin and energy drinks, and dietary remedies) were rapidly expanding from a few special- ized health-food stores to becoming a staple on supermarket and retailer shelves, as well as popular menu options in some restaurant chains. Standard and Poor's reported that more and more consumers expected their food and drink, in addition to tasting good, to be low in calories and offer other health benefits as well. In response to this trend, major food companies began to refocus their best product lines and acquire rec- ognized brands to encourage innovation in new areas for growth with higher profit margins. In 2010, the Organic Trade Association (OTA) reported that U.S. organic- and natural-foods sales grew 7.7 percent over 2009 and represented a 4 percent share of the $673 billion U.S. food industry. Beginning in 2002, the North American organic-food industry experienced major structural change. Large food companies who primarily mass-produced and mass-marketed their food products-such as Nestlé, General Mills, Kraft, Dean, Pepsi, Kellogg's, and Cargill-were caught off guard by the rapid growth of the natural and organic markets. In 2010, "US organic industry valued at nearly $29 billion in 2010, Organic Trade Association, accessed May 2012, http://www.organicnewsroom. com/2011/04/us_organic_industry_valued_at.html. с d "Organic Market Analysis," Organic Trade Association, accessed May 2012, http://www.ota.com/organic/mt/business.html. e Graves, Tom and Easter Y. Kwon. "Foods & Nonalcoholic Beverages: Industry Survey, Standard & Poor's, June 9, 2011, http://www. standardandpoors.com. "Organic Market Analysis," Organic Trade Association, accessed May 2012, http://www.ota.com/organic/mt/business.html.; "Organic Production, The United States Department of Agriculture, http://www.ers.usda.gov/data/organic. "Organic World: Global Organic Farming Statistics and News," FiBL, accessed November 23, 2015, http://www.organic-world.net/index. f html. CRITICAL INQUIRY, BUSINESS MODEL EVALUATION, AND CASE STUDY 37 mass-market retailers (mainstream supermarkets, club/warehouse stores, and mass merchandisers) sold 54 percent of all organic food.hMANAGEMENT TEAM As Joseph's product lines and sales continue to grow, Faro has maintained all the company's management roles. In 1998, Tom Bean, vice president of administration, was hired as Faro's accountant, and later Faro added other administrative responsibilities as well. Although Faro maintained his charge of production, research and development, and some of the large national sales accounts, he continued to occupy overall control of financial decisions. Both Bean and Robinson became concerned that Faro was not spending enough time and resources developing his management team. Faro agreed that this was a problem after experiencing some difficulty with the La Romagnola acquisition. Faro relied on his management team to keep him in check, stating, "I can find myself fixated on issues; these people are paid to say no and are free to state their concerns." In 2003, Dave Gillen, Joseph's production supervisor, was made vice president of culinary operations and manufacturing; he, along with Bean and Robinson, was paid incentives based on sales and profit goals. Faro believed that his most productive time period was the early morning when he spent time alone in his office. The founder regularly came in before the rest of his management team, often arriving at 4:30 a.m. However, much to Bean and Robinson's dismay, Faro continued to exercise influence over all parts of the business. Faro explained, "I get the work habits from my father. He was always at the bakery and had his fingers, literally, in everything. We both want to control everything." Although Faro was the majority owner of the company, several family members also held small stakes in the company; however, only Faro's top management team members had been given stock options. OPTIONS Faro felt there were still considerable growth opportunities available for his company. After all, Joseph's had been a prime mover, making specialty pasta a main entrée on many restaurant-chain menus, and had success- fully penetrated upper-scale, high-end restaurants. As specialty pastas were now offered at many high-end restaurants, providing attractive margins on their menu entrees, Faro no longer considered frozen specialty pasta as just a side dish or appetizer. Accordingly, he and Robinson maintained that many of their best custom- ers saw Joseph's as the leading brand name for specialty pastas. By early 2008, no customer accounted for more than 17 percent of Joseph's sales. Because of this, Faro expected any future acquisitions to further diversify Joseph's customer base. He did not consider the consumer trend toward low-carbohydrate diets and natural and organic foods as detrimental to company sales. Although Faro also believed that low-carbohydrate diets were more of a fad, he still had concern about the growth in all-natural and organic foods. Correspondingly, he instructed Joseph's R&D group to not only begin working on low-carbohydrate options but also investigate sourcing natural and organic ingredients for its product lines. Faro was also keenly monitoring the recent trend toward gluten-free pastas and other gluten-free food items. Smaller, more innovative food-processing companies were leading the way with gluten-free products. Consequentially, gluten-free food options were beginning to appear on restau- rant menus and supermarket shelves. Despite this, both Faro and Robinson maintained that high-end frozen specialty pasta products would continue to experience growth in the company's critical restaurant market. Faro also did not believe that any of Joseph's current rivals posed a serious threat to the company or its markets. He did, however, see potentially serious threats to his company's market with the entry of some of the major food companies. A few of the larger ones and some major investment bankers approached Faro in regard to selling hiscompany. Faro knew that some of his rivals were also engaged in discussion with these potential suitors. He felt that the company was really at a crossroads. Accordingly, Faro outlined several strategic options: Aggressively try to grow on their own through internal expansions of the product lines and acquisition. (Faro believed that there were several small companies selling products similar to his, but they were selling to markets where Joseph's was not strong.) • Take some time to stabilize their current position by building a stronger management team and adopting some better management systems and procedures, and then grow at a reason- able rate while maintaining their strong margins. Explore selling the company. Selling would provide some of the private investors and man- agement team with an opportunity to cash out, thus earning a good return on their hard work and investment in the company. It would also provide Joseph's with the needed funds to substantially grow the company and stave off rivals. • Explore taking on additional private-equity investors with the goal of moving the company public with an IPO (initial public offering). (Joseph's was still regarded as too small to seri- ously consider this option on its own. Private-equity investors and an IPO would provide Joseph's with the needed funds to substantially grow the company and stay ahead of rivals.)Joseph's with the needed funds to substantially grow the company and stay ahead of rivals.) In Thousands (000) Net Sales Cost of Goods Sold Gross Profit Operating Expenses Indirect Manu. Expense Selling Exp. G&S Expense Total Operating. Expense Income From Operations Other Income (Expenses) Loss on Property Abandon Interest Expense Interest Income Total Other Expenses 2006 13125 8210 4915 2090 1449 3539 1367 280 266 -45 501 Pre Tax Income 875 Source: Joseph's Gourmet Pasta & Sauces, Financial Statements. 2007 17730 7441 10289 3638 2146 1595 7379 2910 | 461 -49 412 2498 2008 21593 9380 2213 4395 2702 1983 9080 3133 353 -35 318 2815 2009 34688 15343 19345 5623 5717 3502 14842 4503 | 444 -40 404 4099 2010 Exhibit 2.1 JGP&S Income Statement 40841 18584 22257 7128 5725 2858 15711 6546 359 -23 336 6210In Thousands ($000) Current Assets Cash Accounts Receivable Inventory Prepaid Assets Total Current Assets Property, Plant & Equipment (PP&E) Gross PP&E Accumulated Depreciation Net PP&E Intangible Assets LT Notes Receivable Other LT Assets Total Assets Working Capital LOC* Accounts Payable Accrued Expenses Total Current Liabilities Long-Term (LT) Liabilities Long-Term Debt Deferred Income Taxes Total LT Liabilities Total Liabilities Shareholders Equity (SE) Common Stock Retained Earnings Total Stockholders' Equity 2006 44 1350 1428 146 2968 7100 -1184 5916 233 653 886 9770 845 1597 108 2550 5349 31 5270 7920 20 1830 1850 2007 30 1180 1908 342 3460 7693 -1847 5846 221 531 752 10058 1037 613 313 1963 4729 58 4787 6750 20 3288 3308 2008 133 1978 1973 149 4232 8807 -2601 6206 209 458 667 11105 0 1684 369 2053 4090 69 4159 6212 25 4868 4893 2009 33 3054 4826 146 8059 10127 -3480 6647 198 1604 1802 16508 769 1938 646 3353 5812 65 5877 9230 600 6678 7278 2010 695 2725 5017 333 8770 11622 -4642 6980 186 810 996 16746 941 1781 601 3323 3830 113 3943 7266 605 8875 9480Faro believes that he was "almost selfish" in how he managed the company. He admits that he has neither an exit strategy nor diversification strategy, and he is not ready to retire. Although Faro had no personal debt in the company, he did not want to plunge the company into significant debt. He believed that to get this company to $100 million in sales, he needed an additional $15 million to $20 million in debt or equity. Faro reported with concern: "We have seen costs creep up on us. In the past we were able to keep costs and margins the same ... do I stay with all my equity tied up in this business or do I sell?" a. What is Joseph's strategy? What is Joseph's business model and value proposition? Take a look at Joseph's financials in Exhibits 2.1 and 2.2. Does Joseph's have a below-average, average, or above- average competitive advantage? What standards or assumptions did you use making your assessment of JGP&S's competitive advantage? b. Faro is the protagonist or main decision maker in the case. Again, without conducting any in-depth analysis, what is your assessment of Faro's ability to think critically and act strategically? What infer- ences did you make that allowed you to arrive at this conclusion?Tufte's Six Principles of Elegant Design¹ "Analytical presentations ultimately stand and fall depending on the quality, relevance, and integrity of their content" - Edward Tufte 1 Comparisons: the fundamental analytical act in statistical reasoning is to answer the question "compared to what?" - show comparisons, contrasts, and differences 2 Causality: In displaying evidence and making comparisons the case researcher needs to make inferences, "what is the evidence saying?" - show and support cause and effect 3 Multivariate analysis: show more than one or two variables. In presenting data, avoid two dimensional displays 4 5 6 Integration of evidence: use everything available to make your case, include words, numbers, images, diagrams, graphics, charts Documentation: Thoroughly describe the evidence. Provide a detailed title, indicate the authors and sponsors, document the data sources Content counts most of all: provide credible and believable evidence. The case researcher needs to provide quality content and make the time and effort to display it properly.
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