Global supply chain management v2 simulation answers

Professor John H. McArthur and writer Sunru Yong prepared this case specifically for the Harvard Business School Brief Case Collection. Though inspired by real events, the case does not represent a specific situation at an existing company, and any resemblance to actual persons or entities is unintended. Cases are developed solely as the basis for class discussion and are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

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S U N R U Y O N G

Ceres Gardening Company: Funding Growth in Organic Products

Jonathan Wydown, CEO of the Ceres Gardening Company, scrutinized the figures presented by Annette O’Connell, vice-president of Marketing. It was December 2006, and the two were finalizing the firm’s marketing strategy and objectives for 2007. Having just received the latest industry report on growth and trends, they discussed the implications for Ceres (see Exhibit 1). O’Connell observed:

This report confirms what we believed—growth in organic gardening products is strong, and the trends should support long-term growth. And our own growth is outpacing the industry, especially since we launched the GetCeres™ program. We are clearly doing something right, and we’ve got to remain aggressive.

Wydown nodded. It was true that Ceres had shown impressive growth, increasing revenues by over 70% in just five years while growing profits by over 25% (see Exhibits 2 and 3; also see Exhibit 4 for additional information on finances). He had set ambitious goals for the company, and now they had to focus on executing the 2007 plan. O’Connell’s proposed marketing initiatives for 2007 included expanding the GetCeres™ marketing program, adding new products to the organic seedlings line, and pursuing a pilot program with Menards, a major do-it-yourself home center. Wydown set the report aside and said to O’Connell:

Annette, I agree we should pursue growth, but let’s be sure to think through all the implications. Expanding GetCeres™ and the Menards pilot will require additional marketing spend, plus attracting and training good sales talent. Adding new SKUs1 to the seedlings line opens up opportunities, but we have to be certain the supply chain can deal with the added complexity. We also need to think about the financing needed to drive this growth.

1 Stock Keeping Unit – essentially a different product.

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4017 | Ceres Gardening Company: Funding Growth in Organic Products

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History of Ceres Gardening Company

Jonathan Wydown founded Ceres Gardening Company in 1989 with a mission to promote sustainable organic gardens and landscapes. He had long been a proponent of soil preservation, biodiversity, and natural fertilizers and pest control. Reflecting on the early days of the business, Wydown recalled:

I was confident that the same principles behind organic farming would eventually apply to home gardens and lawns. I believed that consumers would start to recognize the value of avoiding genetically modified seeds and synthetic fertilizers, and I wanted to build a business that was consistent with my own convictions.

Under Wydown’s leadership, Ceres developed a selection of certified organic seeds and seedlings for vegetables, culinary herbs, and flowers.

Ceres’s principal farm was located in central California. As the business grew, Ceres expanded its product offerings to include more open-pollinated, organically grown, and heirloom varieties. The company also added live plants, such as one-year-old fruit trees. Customer demands quickly exceeded Ceres’s capacity, so Wydown developed a network of small, independent organic farms, offering them a commitment to purchase goods in exchange for an exclusive supplier relationship.

Sales and profits grew steadily through the late 1990s and early 2000s. Wydown took Ceres public as a microcap in 1999, giving the early investors an exit opportunity. He was particularly gratified when a number of Ceres’s independent suppliers and key dealers became shareholders. Wydown commented:

The notion of “doing well by doing good” is not an easy one to execute. Getting a unique concept like ours to the next stage requires everyone involved—not just Ceres employees—to believe in the cause. It meant a lot that many of our stakeholders demonstrated their confidence by investing in us. It was a testament to the strong relationships we knew would ultimately drive our success. We are all part of something special, and it’s satisfying to see the stock market recognizing the potential of this model (see Exhibit 5).

Channel Strategy

In the early years, Ceres operated primarily as a mail-order catalog company. The company shipped vegetable and flower seeds to gardeners across the United States. Although certified organic products were significantly more expensive, Ceres developed a loyal following that valued its quality, reliability, and hands-on customer service. A free, bimonthly company newsletter provided gardening tips, introduced new products, and created a sense of community among the expanding customer base.

In addition to the direct business, Ceres had developed a modest retail presence in the early 1990s. The company focused its initial efforts on independent nurseries and garden centers in the northern California region. As interest in organic gardening grew in the late 1990s, Ceres expanded distribution to retailers through much of the western United States. As more garden centers and nurseries demonstrated a willingness to carry organic products, Wydown shifted company resources accordingly, recognizing that sales through the retail channel could overtake the slow, steady growth of the direct business.

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This document is authorized for use only by Feng Liu in Seminar in Financial Management taught by Sherry Jarrell, Temple University from August 2017 to February 2018.

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Whereas the direct catalog and online business primarily served serious gardeners who tended to purchase seeds, casual consumers who purchased their gardening materials at nurseries tended to prefer seedlings (seeds recently sprouted) and more-developed plants. Wydown explained:

The serious gardeners are happy to buy seeds online and get exactly what they want. These consumers already know about Ceres and we value them deeply, but this segment will grow relatively slowly. We believed we would see faster growth among the casual hobbyists who like gardening and like the idea of organics. This segment prefers to buy seedlings or one-year old plants, which are much easier to grow. They are also more likely to buy at a local nursery or garden center where there’s someone to explain what to buy and how to care for it.

Ceres’s early investment in building a seedling and live-plant business gave the company an advantage in capturing the growing retail opportunity.

Building the Retail Business

Despite strong company growth through 2002, management doubted that Ceres was benefiting fully from the organic gardening trend. The company believed that the rapid growth of organic groceries and farmers’ markets was an important leading indicator for home gardening. Market research indicated that many gardeners considered themselves “definitely” or “very likely” to switch to organic. Although Ceres’s direct business remained steady, Wydown sought to accelerate penetration into the retail channel and recognized that his management team lacked the right experience. At the end of 2002, he hired Annette O’Connell as VP of Marketing, believing that Ceres needed her background in retail and consumer-packaged goods.

Aiming to establish itself ahead of its competition, Ceres began aggressively adding new accounts. Other than mass merchandisers and home centers such as Home Depot and Lowe’s, there were approximately 10,000 nurseries and garden centers in the United States. Wydown and O’Connell were confident that Ceres’s reputation for quality and customer service would give the company an advantage over other players. Their biggest challenge, they believed, was that its distribution system had not been developed adequately outside the western U.S., and many of its dealers outside the company’s core region tended to be poorly stocked.

This situation launched a new phase in Ceres’s development. By early 2004 the company had added a new farm and distribution center in Lancaster County, Pennsylvania. At O’Connell’s urging, the company expanded its sales force and added many independent sales representatives. The sales force concentrated mainly on training dealers on how to effectively sell Ceres organic seeds, seedlings, and live plants, which were often 30% to 50% more expensive than conventional products. Ceres also restructured compensation for the sales force to include generous bonus payments for adding a new account or expanding Ceres’s shelf space2 within an existing account. Meanwhile, the product development team continued to commercialize a vast array of new organic seedlings. The tomatoes product line alone grew to 53 seed and 14 seedling varieties.

This strategy led to significant revenue increases through 2004, with growth coming largely from new retail accounts. Even so, the management team questioned if its marketing efforts were sufficient. The prevalence of privately held competitors meant that market data was spotty, but Wydown estimated that organic gardening had grown at 8% to 10% per year. This meant that Ceres had merely kept pace with the overall industry. Further, some major gardening supply companies, such as Burpee Seeds, had moved beyond conventional seeds and begun competing with Ceres in 2 “Shelf space” is a commonly used term in retail industries for how much space (on the floor, shelf, or rack) a vendor has relative to other competitors and products.

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This document is authorized for use only by Feng Liu in Seminar in Financial Management taught by Sherry Jarrell, Temple University from August 2017 to February 2018.

4017 | Ceres Gardening Company: Funding Growth in Organic Products

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select organic lines. Wydown and O’Connell concluded that the best way for Ceres to build its competitive position would be to push even more aggressively to enlarge its dealer base.

The GetCeres™ Program

Wydown and O’Connell believed the key to rapid growth was to enable the average nursery or garden center to stock a sufficient inventory of Ceres’s organic products. They knew that a large percentage of retail sales took place on four or five weekends each season. If a retailer ran out of organic seedling stock at those times, the customer would not return later—Ceres lost the sale entirely. O’Connell said:

The challenge is having plenty of the right product in the store at the right time. Casual gardeners may be interested in organics when they walk in, but they are ready to plant that weekend. They don’t want to deal with sowing seeds in a tray indoors just to grow seedlings—it’s Saturday, and they want to be out in their garden! Depending on what they want to grow, it may even be too late in the season to do anything but plant seedlings. Frankly, these consumers are happy to buy conventional seedlings or live plants if our product is not there.

Unfortunately, many of the newer dealers had approached organic gardening conservatively, limiting their space allocation by carrying seeds rather than seedlings for the casual gardener. This approach did not surprise Wydown. As small, independent businesses, most dealers faced working capital constraints and could not significantly increase inventory without additional financing. They were cautious about a relatively unproven product from Ceres, particularly when the higher price point of organic seedlings meant even more dollars would be tied up in inventory.

It was industry practice to extend seasonal credit terms of 75 or 90 days to dealers.3 Payment for early spring shipments was due in early summer, and payment for summer shipments was due in late fall. The purpose was to encourage nurseries and garden centers to be fully stocked in advance of peak seasonal demand. But regardless of the stated terms of sale, many dealers did not pay for product until they had sold it, and dealers often asked for extensions of their payment terms. Ceres’s experience was that payment was received no later than 120 days after shipment. Seasonal dating alone did not lead to increased sales, but the practice was a prerequisite to serve the retail channel.

Wydown and O’Connell believed Ceres would have to provide additional financing for dealers to reach the targeted inventory buildup. Hence Ceres entered the 2005 season with a new tactic to accelerate growth in the retail channel: the GetCeres™ Program (see Exhibit 6). The company provided even greater discounting and payment terms. New dealers received a 15% discount for a minimum stock order, while existing dealers received the same discount for seedling and live plant purchases exceeding the level of the prior year’s purchases. For such purchases, both new and existing dealers received 120-day payment terms. To protect average gross margins, Ceres successfully raised prices slightly on most of its products.

The GetCeres™ program was based on market research and informal feedback gathered from the sales force. Wydown and O’Connell concluded the company had to become more aggressive to gain share and strengthen its competitive position. O’Connell explained:

3 “Seasonal dating” is a method of extending credit to customers based on seasonal sales patterns instead of a fixed number of days between delivery and collection.

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This document is authorized for use only by Feng Liu in Seminar in Financial Management taught by Sherry Jarrell, Temple University from August 2017 to February 2018.

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We believed deeply in our product’s ability to sell-through4 once we got it to the dealers. GetCeres™ offered very compelling terms to encourage dealers to stock abundantly. We were missing many sales because dealers were too conservative about inventory. GetCeres™ galvanized the sales force, particularly our team of independent sales reps. It made the buying decision much easier for small dealers. Our success in the first year was fantastic, and 2006 has been even better. The retail channel now accounts for over 80% of total revenues. We are still adding new dealers more slowly than we would like, but we know our success with current customers is generating great word-of-mouth and positions us for growth in the years to come.

Financing Company Growth

GetCeres™ accounted for approximately 25% of total sales in 2005, and 35% in 2006. The growth in accounts receivable was financed by a revolving line of bank credit, subordinated notes, and increased use of vendor financing from Ceres’s network of independent farm suppliers. Ceres had a $4.5 million revolving credit facility with a commercial bank. As of December 2006, Ceres carried no balance on this revolver. The purpose of the revolver was to cover seasonal funding needs in the spring and summer months, and since 2001 the maximum credit line had been used at some point each year.

At the end of 2006, Ceres had approximately $9 million of long-term debt repayable over 10 years. The debt covenants limited the company’s maximum long-term debt (excluding the revolving credit facility) to no more than 3.25 times earnings before interest, taxes, depreciation, and amortization (EBITDA). Further, the agreement required the company to be free of bank debt for 60 consecutive days each year and to maintain an EBITDA-to-fixed-financial-charges (defined as interest and long- term leases) ratio of at least 2.0 times (see Exhibit 4).

With respect to its accounts payable, Ceres had extended payment terms from 75 days to 90 days with most of the independent farms in its supplier network. Wydown had negotiated these terms by convincing the suppliers that helping Ceres establish a strong market position in organic gardening would guarantee consistent business in future years. The balances on the accounts payable were carried at no interest. However, Wydown was concerned that increasing these terms any further would likely result in increased costs going forward, putting pressure on margins.

Evaluating Next Steps

While fiscal year 2006 was not yet complete, Wydown and his team were happy with Ceres’s performance and the results of the GetCeres™ program. Wydown reviewed a pro-forma report from the company treasurer showing that company sales had increased from $35.1 million in 2005 to an estimated $42.6 million in 2006—approximately 80% of which were sales to dealers. Based on limited sell-through estimates from the sales force, dealer inventories were approximately $23 million at the end of 2006, compared with $10 million in the prior year. Wydown was comfortable with the company’s financial viability, with the breakeven point at approximately $30 million of revenues under the current cost structure.5

Setting aside the financial report, Wydown glanced at his “to do” list. First, he needed to prepare a motivational opening speech for the mid-January sales meeting. Ceres’s growth was exciting, but it

4 In the retail industry, “sell-through” refers to the sale by the retailer to the end consumer. “Sell-in,” on the other hand, is the sale by the vendor to the retailer. 5 Wydown’s breakeven analysis assumed that all Cost of Goods Sold are variable costs, but that Sales, General & Administration, Research & Development, Depreciation & Amortization, and Interest Charges are all fixed costs.