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Monday, June 30, 2008

New Starbucks Brew Attracts Customers, Flak

Fans of Bold Coffee
Bemoan the Rise
Of Pike Place Roast
By JANET ADAMY


A backlash is brewing against Starbucks Corp. over its Pike Place Roast coffee, which has perked up the company's sales by attracting new business, but has alienated a small yet vocal group of longtime patrons.

In April, the Seattle-based chain made the new, milder brew the main drip coffee at its about 11,000 locations across the country. The idea was to offer a more approachable cup of java with a smoother finish.
[A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch. ]
UPI/Landov
A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch.

But the new strategy, which played down the company's more-established robust roasts, has touched off a debate about what customers think Starbucks should stand for: bold coffee for connoisseurs or a tamer brew for the masses?

Much of that debate is taking place on the company's customer-feedback Web site, which the chain launched in March. The site is littered with thumbs-down verdicts on the new roast. Some small competitors have posted messages there trying to woo away disenchanted Starbucks drinkers.

A customer with the handle Westend complained in a posting on the site that the flavor of Pike Place Roast is "weak, watery and no substitute for the bold." Another, ArtM, called the coffee "a fundamental, grievous error." Beccajav derided its finish as "reminiscent of a taste from the dentist's office."

But Starbucks executives say the chain's aggressive marketing of Pike Place Roast has been a success. Since its introduction, Starbucks' sales of drip coffee have risen by between 5% and 15%, depending on the part of the country, the company says.

"Our satisfaction metrics are up across the board," says Rob Grady, Starbucks' vice president, global beverage. Most of the sales increase in drip coffee has come from new customers "that historically might have not come into Starbucks," he adds.


Starbucks used to brew three types of coffee each day: one bold, one mild and one decaffeinated. The lineup changed weekly.

Now Starbucks outlets serve Pike Place Roast in regular and decaf versions every day. In the morning, stores also brew one of the chain's six bold flavors, like Gold Coast or Caffe Verona. But most Starbucks no longer brew a bold coffee after noon.

The new coffee has clearly struck a chord with some coffee drinkers. But other Starbucks patrons complain that it's gotten hard to buy the stronger-tasting blends on which Starbucks built its reputation. Two weeks ago, after getting thousands of pleas on its Web site, Starbucks again started brewing bold-flavored coffee in the afternoon at some of its locations.

Since New Coke flopped in the 1980s, food and beverage companies have been cautious about changing the taste or formula of their signature offerings. McDonald's Corp., for instance, has kept quiet about the changes in its cooking oil and Big Mac sauce in recent years, in part to minimize the potential for a backlash.

"The worst thing you can do is turn away your loyal customers," says Ron Paul, president of the food consulting firm Technomic Inc. "It's a very risky strategy."

For Starbucks, however, the controversy has succeeded in creating a buzz around the chain's brewed coffees after years in which it largely neglected them in favor of its fancier and pricier coffee-flavored drinks.

Starbucks' Mr. Grady adds that the chain's customers who want a stronger blend of coffee can always ask the barista behind the counter to brew them a cup specially. But some regulars say strong coffee shouldn't require a special order at a chain that popularized it. And some customers who say they have asked a barista to make them a cup of bold coffee say they have been refused.

Pike Place Roast, named for the first Starbucks, located in Seattle's Pike Place Market, has been widely interpreted as the company's attempt to address complaints that its coffee tastes bitter or burnt. But its executives say that wasn't their goal.

Customers were confused by the frequently changing blends available at the company's outlets and wanted something more consistent, says Anthony Carroll, Starbucks manager of green-coffee quality. Surveys of 1,500 consumers also showed they wanted coffee with a smoother finish, he says.

With Chief Executive Howard Schultz pushing for quick action to reverse the company's sliding same-store sales in the U.S., Starbucks developed Pike Place Roast and put it in the company's stores in six months. That's about a year less than it typically takes the chain to refine and implement major new ideas.

Last fall, Mr. Carroll and his colleagues "locked ourselves" in a tasting room at Starbucks headquarters and went through at least 50 coffee blends to settle on the new flavor, Mr. Carroll says. They adjusted the taste by changing variables like the temperature at which the beans were roasted.

"We know what the Starbucks profile is -- it's very near and dear to all of us -- and we weren't going to waver from that signature Starbucks flavor," Mr. Carroll says. He and his team narrowed the field to a group of blends that Mr. Schultz tasted to help make the final choice. Earlier this year, Starbucks tested the coffee with consumers, mostly in the Seattle area.

The new blend won Starbucks a more favorable review from Consumer Reports than the magazine's 2007 assessment, which declared Starbucks coffee "burnt and bitter."

"If you're a confirmed Starbucks drinker and like the taste you're familiar with, this may not be for you," the magazine wrote in a May posting on its Web site. "But if you're looking for coffee with a mild, medium-roasted flavor, Pike Place Roast might be the one to try."

Jolene Tapie of Rancho Cucamonga, Calif., decided the new coffee wasn't for her. "I just couldn't believe that Starbucks would even serve something that bland, tasteless, watery," she says. Ms. Tapie used to visit Starbucks at least three times a week on her way home from her job in a high-school records office. But when her nearby Starbucks replaced the bold blends she favored with Pike Place Roast in the afternoon, she started going to local coffee shops instead.

"I am shocked and disappointed that you have abandoned your original vision," a poster identified as WestPalm wrote on mystarbucksidea.com, the company's feedback site. "You need to wake up before it's too late." Thousands of votes of support for his stance and others like it helped persuade the company to restore a bold coffee variety to the afternoon lineup at about 900 of its locations.

Mr. Grady says Starbucks anticipated complaints. "Every time we change something ... there will be customers that liked it the way it was," he says.

Airlines hedge against soaring fuel costs

Since 1999, the program has saved Southwest Airlines $3.5 billion
DALLAS - The computer screen on Scott Topping’s desk at Southwest Airlines flickered with row after row of dates and numbers, but they had nothing to do with arrivals and departures.

They tracked the price of oil futures for the next several months, and they told a grim tale: No letup in sight from record prices for jet fuel.

“We’re on a one-way street right now,” Topping said as he hunched over the screen, shaking his head.
Story continues below ↓advertisement


It’s Topping’s job to oversee Southwest’s battle to control surging fuel costs. It is the most successful program of its kind in the airline industry.

In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period.

Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest’s $34 million profit.

What is hedging?
Hedging is a financial strategy that lets airlines or other investors protect themselves against rising prices for commodities such as oil by locking in a price for fuel. It has been described as everything from gambling to buying insurance.

Airlines can hedge in several ways, making financial transactions with banks, energy companies or other trading partners.

They can buy contracts for crude oil or unleaded gasoline, and reap a gain if prices rise, offsetting the higher cost of jet fuel.

They can buy a “call option” that gives them the right to buy fuel at a certain price.

They can also use collar hedges, a combination of rights to buy and sell at set prices (“call” and “put” options). Collars provide protection from a decline in prices but less upside if prices rise.

Airlines also use swaps, contracts that require them to buy oil or fuel on a certain date at a set price. These are risky — one party in a swap wins, the other loses.

A risky business
Most airlines use a combination of strategies to reduce risk.

The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year.

As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year’s fuel needs at $51 per barrel instead of the current price of more than $140 per barrel.

But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months.

Airline executives say hedging is not a bet on the direction of oil prices.

“We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you’ve got to be in the market actively without an opinion as to what energy prices will do.”

But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire.

In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading.

Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging.

Southwest's success
At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs — even hiring experts from the oil industry to show them the ropes — said Peter Fusaro, chairman of Global Change Associates, an adviser to hedge funds.

That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous.

“The problem was that most carriers had terrible creditworthiness and couldn’t hedge,” Fusaro said. “Counter-parties feared the carriers would renege on their trades.”

Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today’s prices.

Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year.

While other carriers plan to slash flights later this year — some contracting by more than 10 percent — Southwest expects to grow, although more slowly than it would like.

And Southwest has avoided the kind of fees that annoy passengers. It doesn’t charge for checking luggage or buying a ticket over the phone, doesn’t add a fuel surcharge to the fare, and still gives out free sodas and snacks.

Fuel crisis looming
But how long will the joy ride last?

The bulk of Southwest’s hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices — say, $200 per barrel.

Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years.

“It’s starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor’s. “They’re cutting back growth plans for the first time ever and exiting some unprofitable routes.”

Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges.

Among possible sources of the money are higher fares, international service, in-flight entertainment for a charge, and selling hotel rooms on its Web site.

Snyder thinks Southwest can pull it off by following its current strategy of expansion in places like Denver, Philadelphia and Baltimore, where rivals are cutting flights.

“This is a company,” Snyder said, “that has always taken advantage of others’ misfortune.”

Friday, June 27, 2008

Bill Gates and Warren Buffett Discuss "Creative Capitalism"

via Creative Capitalism by Conor Clake on 6/26/08

This is the transcript of a discussion between Bill Gates and Warren Buffett about Bill’s concept of “creative capitalism.” The discussion, over lunch at the Gates residence in Medina, Washington, took place on May 15, 2008. Also at the table were Melinda Gates, Josh Daniel of the Gates Foundation, and me. I started by asking Warren what he thought of the whole idea. As you can see, he didn’t fall for that one.

--Michael Kinsley
Warren Buffet: I would rather have Bill, if he will, give me the main points.

Bill Gates: Well it’s not completely well defined. It’s a phrase that I used in a speech at Harvard a year ago, because I totally believe in markets as such powerful forces for drawing out innovation and creating things that are sustainable. And yet, you do get trapped in this situation where the markets serve where the dollars are, so you don’t get markets meeting the needs of the poorest. And so how do you bootstrap or support the needs of the poorest so markets are reaching out to them. I mean, when I view the last hundred years as an experiment in how good markets are, the answer is very, very clear and very strong. It’s one of those things that’s so clear people won’t even discuss it with you anymore. Like in this [Edward] Teller biography: he says, Look, if he didn’t believe in innovation, he would have been a communist. If the economy is a zero-sum situation, then you ought to try some crazy sharing thing. It’s only the innovation and pie-growing activity that made Teller feel comfortable with the capitalistic approach. And I think that that’s been validated.

You often hear people saying that companies should do something besides profit maximization. And it’s amazing how strong a message is hidden in words like “diversity” or the broad term “corporate social responsibility.” Warren and I were just at the Microsoft CEO Summit for the last couple days and it was amazing how many of the talks were about how a company needs to have core values of who they are and what they do as the thing that makes the employees feel they have a purpose and guides their action. And how that needs to be really at the center, even more so than the short-term profit metrics. Jack Welch was very good on that and Lee Scott [CEO of Wal-Mart] was very good on that, I think in a very sincere way. I think it’s more true all the time.

Bill George [of Harvard Business School] ran the leadership panel, and he was saying how the younger generation really wants to go to work with people who have a purpose. So what I’m saying is when people write down that purpose, when they write down their values, that an element of that should be: what can we do based on our skill set, our innovators, whatever unique capacities we have as a company--what can we be doing for the poorest 2 billion? And that can either be taking more risk in terms of trying to develop markets there, which is C.K. Prahalad-type stuff, or just doing things like the Merck donation that are not profit seeking and yet not giving up huge percentage of profit.

So somebody can read the words “creative capitalism” and say, “Okay, Bill Gates said that you should serve the poorest 2 billion and ignore profit.” That is not what I intend to say at all, but then I am being a bit ambiguous about how far you go in being willing to give up something. Am I saying one percent? Two percent? Three percent? Nobody who sets these dual roles is very good about being clear. I mean, what do they say you’re supposed to give up for corporate social responsibility. Well, they’re not willing to be numeric because they feel like the two goals, profit and social responsibility, aren’t totally at odds over time—or diversity, or whatever the value is.

I understand it best in terms of the big companies of the world: pharma, banks, technology companies, food companies. Buying from the poor world, supplying to the poor world, having scientists and innovators who come together to think about the poor world. It’s best defined for me there, and then I think, “Okay, how concrete is this?” I go back to this thing of: Okay, if all companies did as well as the best do, then it would be pretty dramatic in terms of the rate of improvement for the poorest. And a year from now I’ll know a lot more about this, because in my new time back at the Foundation I’ll meet with heads of pharma, heads of food companies, heads of…I’ll meet a lot of these companies and try and get a sense of, do they agree that in their hiring it would help them, do they agree that in their reputation and maybe seeking long-term markets it would help them and see how concrete a response is possible.

Warren: But as Bill was talking, it just occurred to me that if you don’t trust the government to do a lot of things very well—and business will never trust them to do that; rich people will never trust them to do that—and if, on the other hand, the honor system doesn’t work particularly well in terms of how many people behave (and this idea just occurred to me ten seconds ago so it will take a lot of refining): what if you had three percent or something like that of the corporate income tax totally devoted to a fund that would be administered by some representatives of corporate America to be used in intelligent ways for the long-term benefit of society, This group—who think they can run things way better than government—could tackle education, health, etc. or other activities in which government has a large role. And it would have this forced funding of three percent of corporate profits or some sum like that. Ace Greenberg used to insist that all the managing directors of Bear Stearns give four percent to charity, and in December he went around and talked to everyone who hadn’t yet given his four percent. And he told all the Jews that they had to give any shortfall at year end to Catholic Charities, and he told the Catholics they had to give it to the United Jewish Appeal. Well this would be a variation on that. Take three percent—pick a figure—of corporate income. That would be, perhaps, $30 billion a year (you would exempt small companies). If there are things to be done in society that the market system doesn’t naturally lead to, something like this would be a supplement to the invisible hand. It would be a second hand that would come down for society—administered in a business-like manner—and it might be interesting to see what a system like that might produce.

Bill: You might want to say that companies could include the cost of putting their best innovators onto the problems, and say that if you don’t do that, then you have to pay it out in cash and it goes into a pool for the businesses that do have the innovators and might want to devote four percent or five percent. When we go to a drug company and say, “Work on a malaria vaccine,” it’s completely unreasonable to expect them to fund it themselves. And so you do get this weird thing--I don’t know how much I’ve said this in speeches; I think I’ve said it privately more--where it’s better for a large drug company to say, “We don’t work on the diseases for the poor. But if we did, we’d give it away. And then you have these other drug companies that do work on diseases for the poor that face the fact of saying, “No, we at least want to charge our marginal cost for this thing, and because we put our best people on it we want some credit for having done this,” but they actually get discredit because they’re charging their marginal cost, where the other guy could pontificate and say, “Yeah, we don’t happen to have any, but boy we wouldn’t be like those bastards and charge for the thing.” So you get sort of adverse selection. It’s a sticky wicket. As soon as you get in it’s like, Oh no, I’m expected to do more because I’m doing something.

Warren: The market system is always going to take care of the medical needs of the rich . . . if a rich guy wants to take out a young gal, you’re going to sell him Viagra and be able to make money doing so. Basically, the market system will make that research worthwhile. But it won’t make research worthwhile for some disease that is indigenous to the poorest parts of the world and not present elsewhere.

Mike: Two of the biggest categories of creative capitalism seem to be, first, one way or another, a corporation gives away money or money equivalents like the time of its best employees, and second, corporations seeking out profit-making opportunities in poorer countries that they otherwise might not. Let me ask you about the second one. It’s sort of like the famous joke about the economist who sees the ten-dollar bill on the ground and says it can’t be there, someone would have picked it up. Why does it require creative capitalism to…I mean, if there is great opportunity there, why aren’t people doing it already?

Warren: Market opportunities will be filled. I think the present system works pretty well in terms of real market opportunities. Now there are a lot of people who would like things to be market opportunities that aren’t market opportunities. But I don’t worry very much about real market opportunities not getting filled.

Bill: You definitely want to encourage people to go into countries where it would be normally riskier and they might not choose to go. A country like Vietnam is improving its situation without much help from creative capitalism. They’ve gotten governance basically right, the education thing is right, they’re getting population growth at a level where they can really feed and employ their people. It’s a spectacular thing. In an earlier question we talked about which are the most important elements. Government plus normal capitalism--really good government plus normal capitalism. If you can have that, God bless you, that is such a fantastic thing. It works very well.

But, when you get this problem of these diseases-- it’s almost too bad, this sounds like an awful thing to say--but there are diseases that are mostly in poor countries. When that’s not the case you have trickle down, which eventually will work for the poorest, because drugs usually have a high cost of development that gets recovered in the rich world and then as they go off patent they’re sold for marginal cost and everybody benefits. And so the fact that malaria was eliminated in the United States and so they don’t need a malaria vaccine, it’s a tiny bit of a tragedy, because you don’t have all of these brilliant minds just seeing that and acting on it and those economic dollars. So I do think we have some real traps where you need creative capitalism. Like getting micronutrients to the poor, getting these drug discovery things to get done. Trying to use the cell phone and network in a different way. The rich world can fall into a way of doing something that works for them that doesn’t work for the poor world and then they go off on very different paths. Ambani, the Reliance guy, [conor, find link pls]who’s very capitalistic, I mean he’s going to do some philanthropy, but he’s mostly in business. He’s chosen to go into the retail business in India. He’s in the energy business mostly. He split things up with his brother, but he kept the energy business. I said, “Why are you doing that?” Well, he’s kind of excited about it, but that would do a lot of social good. He was explaining how they use technology so that 50 million farmers who didn’t used to be able to sell their stuff would be able to sell their stuff. Anyway, so there are great things that capitalists are willing to take more risks in these countries and feel they get some reputational benefit for taking risks in these countries, or they think about long-term growth. So that boundary of how much are you pushing them beyond their normal comfort level to take a risk that will this help them to hire better employees, or will this eventually become economic? The creativity part is partly biasing them towards taking those big risks.

Warren: The market also gets distorted where you feel you’re going to get screwed after going in to a country. You’re going to set a higher threshold on expected returns, if you think there’s a fair chance they’re going to expropriate your assets. And, if there is no rule of law at all, you may skip the country regardless of possible returns.

Mike: But that’s rational.

Warren: Yeah, absolutely rational. Now the counterbalance of that is to have a federal Ex-Im bank or something like that that says if you go to, say, Indonesia and they take your assets away from you, well at least they guarantee you will get your cost back. But government has a role to play in that. Otherwise it is perfectly rational for me to say I’m not going to go back to Indonesia again because we got screwed. That will always be the case with some countries, although I think it’s way less of a deterrent now than it was 25 years ago. Nevertheless, expropriation risk—including confiscating taxes that might later be imposed—will still deter people bringing goods and services to people in some areas of the world.

Mike: When you talk about the comfort level, Bill, is that...can people or sometimes companies irrationally seek comfort and avoid risk? And if it’s not irrational, why should you force people to do it?

Bill: Well rationality only goes so far. If your young employees are saying to you, “Hey, should we be trying to develop the market in Africa?” Rationality might say to you, “Gosh, we don’t pay much attention to that, why bother?” There’s a lot of latitude in terms of what’s rational. If you feel like getting involved in that, if it has this positive benefit, then you’ll put more time into the specific strategy that is rational to going after that opportunity and maybe coming up with something that in the long term is very rational.

There are multiple rational paths that companies have to go down. If you said to a company, “Hey your diversity policy made you do irrational things versus what you would have done without a diversity policy,” they will say, “oh no, it just opened our eyes to better rationality.” And some of them will be telling the truth. I think a lot of them will be telling the truth. Some will just--of course they don’t really know. You don’t get to live path A and path B and then subtract and say, “Okay, the one that is bigger is the rational one and the other one is kind of the stupid one.” So it is a bit like diversity to say that, hey, if you’re a food company with geniuses about putting vitamins into foods that putting some portion of those people on to these needs of the poor people, you’re really being pressured to do that and find the smartest way with all your IQ experience to make that work for you and to the degree that it’s money losing, do it in a way that the visibility and reputational gain pays you back from the other customer base.

Warren: I would say that it may well be at Microsoft that it makes some difference in terms of whom they hire. But I think if you took Kraft versus Kellogg versus General Mills—and General Mills happens to be in Minneapolis where they have that five percent corporate donation program—I don’t think it has any real effect on the quality of who applies for jobs at the three companies. You take GEICO. If GEICO has a policy of being green, or whatever, when we are recruiting, I don’t think it makes much difference to prospective employees.

Mike: So let’s talk about situations where creative capitalism is frankly going to cost you something and it’s like you’re reducing the return to shareholders. And question one is why do corporate managers have the right to do that?

Warren: I don’t think they do. We (Berkshire Hathaway) had that shareholder designated contribution program for 25 years. Basically, I don’t feel I’ve got the right to give away shareholders’ money, though I feel our shareholders should have the right to designate their share of profits to their own charitable priorities. I mean I may believe in women’s reproductive rights or something like that and if I want to give all my personal money to that, that’s fine. But I don’t think other shareholders should have to support my preferences. However, I think it would be nice if we had a mechanism, like we once did, whereby the people who favored adoption would be able to devote their proportional share of Berkshire’s charitable funds to that purpose.

Mike: I thought you had a program like that.

Warren: We did for twenty or twenty-five years, but we had people who weren’t our employees, but who work with us, who were getting so much heat on them that they were losing their source of employment and earnings. I just wasn’t willing to fight them on that. When the government bureaucrats allocate the taxpayers’ money, all the rich guys get mad about it. But when the rich guys are allocating their shareholders’ money, they seem to think that God gave them that right.

Bill: Let me take a case that’s really clear-cut, which is the Microsoft case. We need to have great relationships with governments all over the world. And because we make a product whose marginal cost of production is very low--software--and because information empowerment is so directly what we’re about, it’s not a stretch in any way--the idea that we go into over 100 countries and do these things where we donate massive amounts of software and we even give cash gifts and we train teachers and we make sure we get visibility for that and we make sure when we hire employees they know about that. When we’re competing for government contracts we remind people we’re a good citizen in that country. I can’t do the math for you in some hyper-rational way. I suppose you could go overboard on it, but versus not doing that, Microsoft is absolutely way better off.

Now, the thing we’ve done that I don’t know if we’ll get credit for it--but I love it and I think we probably will--is we have the lab in India specialize on looking out for the poorest. And it was very interesting, because when they came in to present to me, they had a few slides up front that said…they call it bottom of the pyramid, bottom two billion. They had a few slides up front that said PCs are too expensive, electricity is too hard, we’re going to show you something here where Microsoft software actually plays a modest role. And it’s this thing where they use DVDs. It’s really cool. To help teachers and to help farmers. But literally it’s a TV set and a portable DVD player where the best practices, like American Idol, you get the local farmers together, they compete, they video the best one and they create a social event where they take that out and play that DVD. It didn’t use a lot of Microsoft software, but so what. It’s a very clever idea. They’re going to spin off, the people are so committed they’re going to go do this full time and The Foundation is looking at how we can support them as they plan to scale this thing up. So it’s a minor part. If you did the math, I think there were 30 people in the lab who were broadly working on this stuff in a 60,000-person company. Has that got some direct payoff? I bet it does, because there’s just so much leverage in something like that. So I think for the big companies that are in these world markets, there’s a lot.

Take the drug companies. The degree to which government policy affects how they charge for their product, it’s a lot like the Microsoft situation. They want to have good relationships with governments. They want governments to understand a little bit about the position that they’re in. Getting that hearing, they would be the first to say that on AIDS, they made a mistake. That drawing the line that, hey, you should always pay for drugs and not putting the footnote in about the AIDS emergency and how things were priced on that, that was just a mistake. The general principle okay, but they need the big footnote about tiered pricing, health emergencies. It’s a complicated footnote, but they blew it. And now they’re kind of making up for that, some better than others.

Warren: If I’m chairman of Exxon Mobil, though, and I think that Nigeria is a particularly attractive oil province to go to work in, do I give $10 million to the favorite charity of the president of Nigeria, or do I poll the lower class of Nigeria to see what they’d really like done for them and spend the $10 million there? I mean, if you’re really following market economics you do want people to think favorably of you, but different companies may want different people feeling favorably about them, and all this may have very little to do with what society would like if you had a social equation that you were weighing. On a strictly market test, it may be better to have a dictator or his wife think well of you than take an action that benefits his millions of subjects.

Mike: Isn’t there a sort of a catch-22 logic at work where you say that spending this money is justified for the shareholders because the good will pays off in various ways, helps you hire better people, gets you into Nigeria…

Warren: Or keeps you out of trouble.

Mike: Yes. But then if it really does pay off, why do you still have bragging rights? If what you’re buying is bragging rights that you do good, and those have value, therefore it’s justifying in terms of your imposition on the shareholders--well in that case you don’t deserve the bragging rights.

Bill: Yes you do, because you’ve pushed the world in the right direction. There is such a thing as a win/win in this world. If you figure out how to give good customer service, you are allowed to brag about how you have great customer service. If you figured out how to make governments love you by helping the poor people in that country, you get both the benefit of the government loving you and you get to say you helped the poor in that country.

Warren: As long as you don’t say what you’re doing is to get bragging rights?

Bill: No, no. Microsoft is very honest to saying that it’s not purely our doing . Partners and Learning, which is the school donation thing. That’s not purely… we don’t go to the world news and say, “Oh we’re just suffering so much this was so hard.” Ask Merck on the medicine donation thing, the Mectizan. Their employees are very enthusiastic about that. They give update videos from the employees when they get together and all that kind of thing.

The world is more like this. Kids do really want to associate themselves in their fulltime work activity with something beyond just how profitable the institution they’re involved in is. Now, maybe that’s a very elite statement, maybe that’s more an upper-tier, particular group of people, but if you take the big global companies, that’s the hiring pool that they care the most about. I hope I’m right about that, because that gives the win/win element to the part of this that the economics don’t ever develop from.

Warren: The people at Wal-Mart would rather work for an admired company than a company where they’re criticized every day. I don’t think they care that much about the specific policies that lead to the criticism or admiration, but there’s no question you feel better about going to work for a company that’s admired or your kids feel better because they hear different things at school. But at Wal-Mart I think most employees care about the policies that will directly affect them. I’m not sure how much they really care about the other issues, except to the extent they lead to this secondary aspect.

With our shareholder designation plan we had reverse publicity. In the end some people boycotted See’s Candy because of what our shareholders were giving to, even though other shareholders were giving to things they agreed with. They picked out the things they didn’t like rather than the things they did like in terms of our published activities.

Bill: They didn’t even give you the net benefit of the…

Warren: No. We regularly pointed out that it was totally the shareholders making the decision. We had lots of money going to Catholic schools and all that. One guy wrote me and said I don’t care if you give a billion dollars to pro-life organizations and a dollar to a pro-choice organization, he says I’m still boycotting you. People feel very strongly sometimes, often in inverse relationship to the logic of their argument.

Mike: One thing you’re proud of at the Gates Foundation is the way you focus and the way you make very rational, businesslike, and to the extent you can, testable decisions about where you devote your resources. What confidence do you have that this much more amorphous process you’re describing here where corporations want to have good relations with the government of Peru or want their employees in India to feel good and so on will have anything like that kind of discipline in where the resources go?

Bill: Well, discipline is always based on feedback systems, economic or otherwise, and so corporations are very, as Warren was saying, very influenced by reputational feedback. Almost slavishly so. I mean there are some things about how you do corporate structure that just gets done without even that much evaluation because somebody who does a point system on governance has chosen that to get these points we have to do such and such. And this thing would be most healthy if a body of expertise grew up that was probably industry specific that was looking say at the food companies, the drug companies, the banking companies and did on a say yearly basis an analysis of this is what this company did that is in this creative capitalism category and here’s the impact that we think that’s going to have. And that type of feedback system I think is a necessary element of keeping the score in some fair way and making sure that when these resources are used brilliantly, that the best practices are spread and when they’re not there isn’t too much credit. I’ll be the first to admit that it’s very easy because the normal person won’t be able to test the statement. It’s very easy to make statements about this that sound good and only by taking a lot of time to dig in to it do you find out that it had no impact at all, it wasn’t that much money, it was something that we were going to do anyway. Otherwise, there’s a lot of room for fluffery in this space and so you’ve got to bring in expertise and that will probably take a while to develop.

Mike: In Washington, I was always struck by the fact that there would be these lavish parties to celebrate, say, Exxon-Mobile’s contribution to Masterpiece Theater. And then you’d look it up and it turned out well they spent $3 bragging about how wonderful they were for every dollar they spent being wonderful.

Warren: I’ve been on the board of a number of places where I’ve watched the charitable dynamics. One was the Urban Institute. The truth is I could walk in to the CEO of any company and get $50,000 or $100,000 for the Urban Institute if Berkshire owned their stock or if I was on the board or Berkshire was a huge customer. The whole thing was based on figuring out who was connected to whom and one time I brought it up. . I said, “Do you ever list all the wonderful things the Urban Institute is doing and then ask the CEO for his own personal contribution?” They said, “Don’t do that! Just ask for the corporate money.” Having been on a lot of boards, a number of the boards even let the directors make certain charitable contributions and matching contributions all that sort of thing. I think Bill, however, could actually go to Pfizer or some other company and have some real impact. He’s personally contributing substantial sums, which is impressive, he’s calling personally, and he knows the subject. He could have some impact. Very few people can.

Bill: I do draw a distinction between the company drawing on its natural expertise like the drug company doing a drug or a Coke company with its distribution system or Nestle buying more food from poor farmers or helping put micronutrients in that don’t make the food taste bad. I draw a big distinction between that and writing a check. If ExxonMobil employees actually did the Masterpiece Theater thing or some brilliant thing about crude oil because that’s kind of a stretch, maybe they’re drawing on something unique there, but they’re more likely to help out in that they...and they do some of this. They have employee scenarios where there is very high disease and so in terms of trialing drugs they’re good. In terms of reporting oil revenue--anyway, I’m not really an expert on that, but they…

Warren: Well they went along with host countries. I mean it would be crazy if they didn’t. Getting along could mean doing some good things or paying off people or a whole lot of things. But they need to get along with the host country.

Bill: The Foreign Corrupt Practices Act and to the degree other rich countries have adopted that, that really has raised the level of honesty in business worldwide.

Warren: That is for sure.

Mike: There are people who will tell you it has destroyed the United States’ ability to compete.

Warren: Compete in certain areas. There’s no question about that.

Bill: I wonder what industries and how big that is? I know the worldwide benefit is pretty large, so the U.S. loss would have to be pretty big before I’d start to still think it was any type of mistake.

Mike: Well, suppose I was a shareholder of Microsoft or even suppose I wasn’t, but I came to you and said, “Bill, rather than trying to come up with all sorts of ways Microsoft can make the world a better place, some of which--maybe even most of which--aren’t going to help the bottom line, I would much rather you do everything you can do to make Microsoft profitable and then take the money that you made and spend it directly on what you have figured out to be the most efficient way to make the world a better place.”

Bill: I think that would be a mistake because what we get in countries around the world where our employees are volunteering to train teachers in these schools, where they are taking some of the time that we pay them for to train teachers in these schools, and where we’re making cash donations to training--the leverage we get by donating free software, and the leverage we get by having seen countries that do this well--and there are a lot of countries that are very open minded that say, “Hey, show us how to do this well.” And where we can have them go visit the other country and see it. They are really interested in what those pitfalls are going to be and, you know, the world’s not just about money. It’s about expertise. The developing world has a huge shortage of expertise and to that degree Microsoft, either from its rich world employees or spreading best practices from one developing country to the next, has a huge impact, though it’s hard to measure. The amount of money we…say we cancelled all this stuff, it wouldn’t be more than 2 to 3 percent of what we do. It might get about 3 percent because we put a lot of employees’ time into it. In some of the poorer countries it would be 20 percent of what Microsoft does, but not that high.

Mike: And you feel you’ve got a 20 percent payoff even there?

Bill: Well, in those countries it’s when we’re first establishing our business and our business is quite small, and the early relationship with the government is the main thing we’re doing when we go into a country that was so marginal. We weren’t in there before and now we’re in there. Take Indonesia where I just was…we’re down to where maybe 10 percent of what we do is not direct profit seeking but helping education, helping with community centers. It’s about 10 percent. And that’s not counting the value of the donated software. If you count the value of the donated software you can get some big number, but that’s a fanciful number in the sense that it’s not business forgone. There was not a path where those dollars came into our sales number.

Melinda Gates: I keep thinking about the refugee situation where you sent people in to catalogue the refugees. I mean that took expertise.

Bill: Right. This is the thing where when…if you get trained personnel who can go into refugee crises who own a laptop computer and who can just type in who they’re seeing and then the wireless network collects that from all the difference places and you have everybody who’s looking for somebody and everybody who has somebody and they actually print out these little cards that the person could carry around, but they had that database. That’s a very straightforward example: the expertise to get where there’s no real network, but the wireless thing works and then you can train the people on the software before the crisis happens. And everybody likes to give money when the crisis happens; if you give money before to buy the portable computer, set up the software, train the people then it’s more leveraged actually and that’s the kind of thing a company like Microsoft could do because it’s not a huge thing for us.

Our employees got very enthusiastic about it. We showed the video, people volunteered, got involved, even some people left and went and worked full time on that thing. So it’s not because software is magic and corporations have a lot of innovation power. If you don’t, you know, I have this strong belief that innovation is so key to improving the conditions in these poor countries. And they don’t--in terms of their universities, long-term research, people understanding the latest science and how that maps to the problems they have. Talk about a systemic underinvestment where the public good just doesn’t get created. It’s gigantic.

Warren: I think corporations, though, much like many foundations, will focus locally. That’s the natural tendency. If you take that Minneapolis group, you know, it started many decades ago and you really pledged, if you were a major corporation, that you were going to spend a significant portion of profits on philanthropy. Target is five percent, I think.

Bill: Five percent?

Warren: Yeah, five percent.

Bill: Five percent of their profits goes to…

Warren: Yeah.

Bill: That’s amazing.

Warren: They have General Mills, Pillsbury, Cargill, 3M . . . all of these guys . . . everybody did it. I mean you were an outcast if your business was in Minneapolis and you didn’t . . . but my guess is overwhelmingly most of the money went to Minneapolis or Minnesota related things. You weren’t expected to take a world view. Now Target has probably broadened it out as they have become national.

But the interesting thing about our shareholder contribution plan was that nobody was personally soliciting anybody for any cause. There wasn’t anybody putting pressure on, or personal solicitation. Churches were by far the biggest beneficiary of it and schools were second . . . and, of course, corporations normally never give to churches. We had hundreds and hundreds and hundreds of people designating churches.

Bill: To be fair at the operating level to the degree that there have been, you know, community charity type things that are appropriate for that business and are driven not by specific managerial interest but really by business interest, you allow the operating business to continue those things. So when you look at the overall Berkshire picture you really have to go down into those operating businesses.

Warren: We have companies for sure that give more than two percent and then we have others I never look at . . . I’ve never named a charity or said the amount subsidiaries should give. I just tell managers don’t do personal stuff with company money.



Bill: So take Iscar [an Israel-based metalworking company] that Warren just put $4 billion into. They have a policy, and I don’t know enough of the specifics. I’m excited to go see it, where they’re really big on putting their plants in tough places and employing the minorities, which are the Israeli Arabs, as much as they can.

Warren: 20 percent Arab.

Bill: And that is not purely driven by a bottom line thing. It’s a societal contribution, I believe, that they make by the way they do things.

Mike: There’s a third category of creative capitalism, which is like the Red Campaign. Basically, consumers will apparently pay a premium for a product if they know that part of it is going to go to charity. I would ask Warren: isn’t that a little irrational?

Warren: Yeah. I don’t think it works that well. I mean American Express didn’t want to follow through much on it, but I think if you have a specific cause for a short time . . . there’s a local tornado in Omaha or a tsunami far away—it’s both humane and politically correct to respond. I don’t think it’s something that sustains itself over time. There are a few people who will stay motivated on it. But I don’t think that if we announced at GEICO, you know, two percent of your premiums were going to help people around the world, only a few would want to pay an extra two percent. The rest would say reduce my premium and give it to me.

Bill: I agree with that in terms of car insurance. When people buy clothing, you know, my daughter’s not saying, you know, “Do these Juicy sweatpants wear out in N years and have a certain stiffness,” or things like that. She’s associating herself to the degree we fund her to do so with Juicy. And so the Red question, which I admit is out, but I think it’s a great experiment and I’m somewhat optimistic is can you create a brand association for consumers in the U.S. if there are some products like their credit card, their clothing, their cell phone? There are things and you have to be very creative in coming up with new things and keeping those fresh. Is there a brand association with red products that you feel proud that you’ve done that and it’s kind of a cool thing? There are kind of neat new products. Whether that’s just a short-term thing because it has worked short term or something that can really be sustained and get a broad group of products in. That’s where branding people are needed to help us achieve and I think and I hope the answer is yes. I’m not saying that all products in the economy should all go off and have some, you know, bleeding heart 2 percent payoff thing. I’m not saying that at all.

Even if it is grandly successful this will be a tiny part of the economy. These things do add up. You save lives now a days for $200 a year buying AIDS drugs and it’s a pretty powerful message. If we didn’t have Bono to help promote it, you know, we really wouldn’t have had the short-term phenomenon that we’ve had. You can talk to Gap or Hallmark about how they feel about their experience with it. So it’s not going to generate billions of dollars. I think whatever money it raises it also is a nice vehicle for us to raise awareness of these causes and ideally activate people to either volunteer or vote in a way that is beneficial to these causes as well.

Warren: There are 20 other variables, but Gap’s in-store sales are falling month-by-month. There are a lot of other variables. Believe me they were falling before, but it is . . . I think it’s tough to build a sustainable thing. I’m not saying it’s impossible, but I don’t yet see the evidence.

Mike: Is it ever going to work on you as a consumer?

Warren: Never has.

Bill: Well, Warren’s not much of a consumer.

Warren: In fact, I’m not much of a consumer at all.

Bill: Think about how you’re brand conscious in something you buy. When you buy golf balls what do you think? You buy brand.

Warren: You buy a brand. You’re buying what you hope is distance. You do.

Michael: So how much distance would you give up for part of the cost of your golf balls to go to AIDS?

Warren: The difference is a matter of a yard or two. I’m not giving up anything important.

Bill: If brands…brands are about an association and it’s not irrational that there could be a brand that was about being associated with helping with AIDS. It’s a new pioneering thing that…it’s done pretty well so far.

Mike: I just want to take another crack at something. Suppose you were running the world. Would there be a place for creative capitalism like this in it? Or would it be much more rational? Would you say, “Look, corporations should be efficient and produce products and then we should decide what we wish to achieve as a society and we all pay taxes and do it.”

Warren: I would have my own tax system, but the answer is I think I would go the second route.

Bill: I think there are going to be corporations where expertise builds up to solve problems that is not built up any other place. And your hypothetical is a little strange because what we’re faced with is a world with vast disparities in wealth that have to do with what country you’re born into and you wouldn’t have that if you had one person running the world and so, you know, the degree to which a little bit of innovation can make a huge, huge difference whether it’s an LED flashlight or something you can roll to move the water that you used to have to carry.

Some of these innovations--when you see them you say, “Oh, well, obviously that rationally should have happened,” but it only happened because somebody cared. Now you could say in the grand sweep of time capitalistic economics would have come up with that. Well, there’s a lot of suffering between now and eventually that this thing can deal with.

The brilliance in innovations inside universities--we haven’t talked about universities here because I haven’t thought about that as much, although even some of them are starting to get involved. Getting them to take their innovation power, thinking power, awareness raising power, into these things is another part thing that I think is important and I hit a tiny bit on that in the Harvard speech, but we have all this expertise. You need to apply it. Drugs are just such a clear, clear case. The government doesn’t know how to make drugs. They don’t know how to trial drugs. There’s no government in the world that’s in the business of doing that. So you’ve gotta send the signals…now I admit that you could do it if you had a single world government. You could do it just by giving money to the poor and then letting the market speak out. I think you could design a utopian system that would do it that way and then you wouldn’t have to rely on--you could have robots working at the company. Whereas here I’m actually explaining the fact you have people who care about humans working at the company.

Warren: But I think the most realistic model actually can be the Gates Foundation. If you’re really looking for ways to take huge amounts of resources over time, and they are going to be huge aggregations of resources, and you show the world that something is a better system than government and will work better and can attack things that government can’t and so on; and that will use resources efficiently. I think people will look for that--not 100 percent of the people, not maybe 50 percent of the people, but a lot of people will. But I think it could be a demonstration project like nothing else the world has ever seen.

Michael: The retiring CEO of the Gates Foundation--she’s very excited about the idea of a middle institution that’s not non-profit and it’s not for-profit. It’s a low-profit, and I think [Grameen Bank founder] Muhammad Yunus has suggested this and basically it runs like a corporation except all the money is put back in.

Bill: Well, there are such things, you know, there are mutual operations that are like that, you know, the recreational co-op, which is pretty sizeable now a days…What percentage of the hospitals in the U.S. are under that type of structure--50 percent, 60 percent?

Warren: If I owned 100 percent of Berkshire I could have set it up that way. But I think the model of intelligent, private philanthropy will look superior to governmental spending in many areas. I don’t think there will be a shortage of funds over time and I think there will be a lot of people who will make a lot of money who don’t now have the faintest damn idea about how to best funnel that money back to society, but will, nevertheless, feel like they want to funnel that money back to society. I think intelligent private philanthropy has a huge potential.

Bill: Yeah. I would say two things about that. One is there will be an effort with more to spread the word about how much fun it is to do philanthropy--either the way I’m doing it, where you get deeply involved, or the way Warren’s doing it, where you look and you pick somebody who you’re excited about their approach and you back them to go do it. So I’m going to meet some percentage of the very rich people in a quiet way and encourage them. It will be all their credit if they choose to do it, but I’ll say that (a) philanthropy is good, and (b) the hardest part of philanthropy, which is getting to poor countries because learning how to do that, knowing it’s effective, dealing with some of the challenges there, you know, showing them where that works and in a few cases maybe they will want to partner with us. I think upping that goes along with upping the corporate part, which is the creative capitalism, and goes along with upping the academic attention to the problems of the poorest.

Things like grand challenges are another kind of innovative thing here where we might dial a grand challenge in micronutrition and it might be some guy at Nestle in that food lab who sees that thing and says he can solve it and he needs a little bit of forbearance from his managers to take, you know, five or 10 people and write it up and come to us and say they’ll transfer that technology or something. It doesn’t take some big diversion of a profit.

Also, to the degree The Gates Foundation works, we are engaged in these things where companies like GlaxoSmithKline--even though we’re funding a lot of the work--they’re putting some of their top innovators on the malaria vaccine. You’ll never figure out the numbers, but there are some opportunity costs where those people could have worked on something else. Now if one or two of them were people who said they would have retired if they couldn’t work on this or figuring out how fungible that resource really would have been for them and what it would have done. It would be pretty hard to beat America on that, but they are really giving up opportunity costs to do these things. If we work it will be partly because people like GSK are going along with us or [India’s] ICICI Bank are going, or Nestle are going along. And that list, you know, a year from now will be a lot longer.

Warren: Over the years, by his letter, Bill will be talking to more rich philanthropists or potential philanthropists, you know, than anybody ever has in the world. I mean Carnegie is still talking 100 years later or whatever it may be since writing The Gospel of Wealth. Bill’s model can have a huge potential and it can have a huge potential with smart people who may think of variations on it. He’s in a unique position to talk to the world on it and the world wants to hear what he has to say. It’s a great opportunity.

Bill: Just to be clear what Warren’s referring to: I don’t know if you’ve heard, but I’m going to do something that in the world of philanthropy that is much like what Warren’s annual letter is in the world of business. And the target is that the first one of those will come out this January.

I do think talking with rich people globally, they will be interested. Not necessarily that they will do anything, but for me to say, “Oh, wow, this went well, this went poorly. Damn these governments who can’t do this and that.”

Mike: You get the letter if you could give away money and you don’t actually have to be giving it away yet?

Bill: The letter will be on the Internet. We’ll promote it as, “Hey, maybe you’d be interested in reading this thing.” And there will be a number of constituencies, but potential givers are a big part of it. Somebody who works at a UN agency I bet, you know, some of them will read it. Some people in poor world governments will read it. Some people in the drug industry, who knows.

Warren: They will all read it every time.

Bill: I’m going to get the jokes from Warren and so that is--

Melinda: The clean ones.

Bill: No Mae West.

Warren: It’s got huge potential, because you’re actually doing it. I mean it has so much more impact than some academic writing about it or something. Everything goes through your mind and they love it. They want to know that. They get a chance to sit down with Bill Gates and talk about philanthropy or listen about it anyway. They can see what you’ve done and they can say all kinds of things. Really, look at Carnegie’s thing. I mean it isn’t that amazing what he wrote or anything like that, but it influences people a century later. I mean this has got 100 times the potential.

Thursday, June 26, 2008

Sharper Image Lives -- as a Brand

By JEFFREY MCCRACKEN and PETER LATTMAN
Retailer Sharper Image was left for dead in February. Now, four months later, the bankrupt purveyor of air purifiers and nose-hair clippers is coming back to life.

This time, though, it won't have stores with $5,000 massage chairs where customers can relax. Instead, Sharper Image will live on as a virtual brand name, its moniker rented to other retailers that want to spruce up the appeal of a vacuum cleaner, pet robot or pair of sunglasses.

This Sharper Image retail store in International Plaza in Tampa, Fla., is one of the outlets left in the chain that is scheduled to be closed down.

Leading the revival are the country's two largest retail liquidators, Hilco Organization and Gordon Brothers Group LLC. Historically, these companies have served as a stockroom Grim Reaper, squeezing the last few dollars from a dying retailer's inventory.

But over the past 15 months, the two have moved aggressively into the brands themselves. So far, they have spent a combined $250 million on brand acquisitions, largely via bankruptcy-court auctions. Last fall they acquired furniture chain Bombay Co. In recent months, Hilco has purchased fashion brands Ellen Tracy and Halston.

In their largest acquisition to date, Hilco and Gordon Brothers had to beat back eight other bids for Sharper Image. They paid about $49 million, including roughly $33 million for the Sharper Image brand name. The companies partnered with brand-management firms Windsong Brands LLC and Bluestar Alliance on the deal.

The San Francisco-based retailer, which started in the late 1970s as a quirky catalog company that sold jogging watches, grew into a national chain, cornering the market on Ionic Breeze air purifiers and other high-tech gadgets. The store made it into the film "When Harry Met Sally..." when Meg Ryan and Billy Crystal tested a home karaoke machine. Sales tumbled in the last few years after a Consumer Reports article questioned the safety and effectiveness of the air purifiers.

"The store always generated a lot of foot traffic. But some brands are retailers, and some are better as wholesalers. Sharper Image is better as a wholesaler," says Hilco Consumer Capital Chief Executive James Salter. He adds that the brand will probably need a $5 million investment to analyze new products and market the name to product makers and other retailers who might use it.

Mr. Salter envisions Sharper Image products being sold around the world via infomercials, Web sites and catalogs. Or they could be set up in the aisles of a Target or Best Buy. One possibility: a Sharper Image treadmill with a computer and GPS system that would allow a user to race against others around the world in real time.

Mr. Salter says the high-tech name could generate annual retail sales of $1 billion. That would be a huge leap from its sales of $375 million in 2007 -- and from its sales in any recent years. A branding company typically earns 2% to 3% of a brand's revenue in royalties.

Hilco and Gordon Brothers are by no means the first to pursue a brand-licensing investment strategy. Publicly traded companies like Iconix Brand Group Inc. and Cherokee Inc. are leading players in an increasingly crowded field.

Sharper Image's new buyers take inspiration from such exhumed brands as Polaroid, which was bought out of bankruptcy in 2001 by a private-equity firm. Today, Wal-Mart Stores Inc. and Target Corp. do a brisk business selling an array of Polaroid products, including digital cameras and LCD television sets.

The strategy is not without risks. Nexcen Brands Inc., a publicly traded brand-management firm that owns fashion label Bill Blass and interior-design brand Waverly, recently told its shareholders that it faces a cash squeeze and is laying off workers and selling off assets to raise capital.

But dormant brands are more valuable than ever as mass-merchant retailers look for new ways to lure customers into their stores. Kohl's Corp. this month announced a licensing agreement to revive and sell the Hang Ten surfing brand in its stores. Earlier this year, Wal-Mart relaunched the Ocean Pacific apparel brand, which is owned by Iconix.


Mr. Salter says that earlier this year Hilco spent about $17 million for Ellen Tracy, a women's clothing line, and that it expects to double its return. One deal already in place is a five-year contract with G-III Apparel Group Ltd. to sell Ellen Tracy coats.

But before Sharper Image's new owners reinvent the brand, they're spending the summer winding down business at the remaining 80 stores of what was once a 180-store chain.

On a blisteringly hot day in Manhattan earlier this month, Gordon Brothers principals Bradley Snyder and Stephen Miller -- the duo that led the Sharper Image acquisition -- stopped in at the chain's flagship store on 57th Street. With the store's air conditioning broken, Mr. Snyder tried to cool off in front of a Vornado art-deco-style fan marked down from $130 to $100. He also explained the sensitivity of this particular closeout sale.

"No bright orange signs. You can't be too schlocky," said Mr. Snyder, standing underneath signs proclaiming "Nothing Held Back" and "Entire Store 20-40% Off." "You want to move the merchandise, but you can't impair the brand."

Wednesday, June 18, 2008

'Copy This! How I Turned Dyslexia, ADHD, and 100 Square Feet Into a Company Called Kinko's'

By PAUL ORFALEA AS TOLD TO ANN MARSH

By 1983, we were doing about $70 million in sales a year with slightly more than 120 stores. We also had about 30 independent-minded partners running various corners of Kinko's. We were 30 partners—with an average age of about 28—motivated by our own value systems, ideals, and ambitions. With scant input from the head office, each person made his or her own decisions, whether they ran a single store or a string of them. The growth, even at that early point, was getting out of hand.

At the time, our head office was located on the second floor of the El Mercado shopping center in Santa Barbara. We were experiencing growing pains. The first half of the eighties was a time of furious growth and none of us had bothered to put certain fundamentals into place. I remember Dorothy Sandow, who used to do the books in our office, wondering out loud, "How will we stay the same as we grow?" Good question. I didn't have the answer. We'd grown so fast that we hadn't even bothered to secure trademark protections for ourselves nationwide. We hardly had any written agreements with anybody; most of our business was conducted on a handshake. Aside from our status as independent Subchapter S corporations, we lacked any structure to speak of.
[Journal_Report-Small_Business_BOOKS_Orfalea]
Workman Publishing Co.

To get some perspective on things, I enrolled in the Owner/President Management Program at Harvard Business School, which I attended three weeks a year for three years. While sitting through classes there (and never taking a note, though I did read my case studies), I realized we needed somebody—an outsider definitely and maybe an academic—to help us continue to grow while still retaining our unique culture and not killing each other in the process. My hunt lead me to John Davis, who got his doctorate at Harvard Business School and was an assistant professor at USC at the time. I called up John to ask him to meet and talk things over with me. John agreed to, even though at the end of our first conversation I abruptly hung up on him—"I gotta go," John remembers me saying, leaving him listening to a dead phone line. I guess he understood I was busy. Somehow, he was intrigued enough to follow through.
RELATED ARTICLE

[Books]
Me, Me, Me
So many entrepreneurs are writing books about how they made it. Their books, though, aren't nearly as successful.

John's association with Kinko's would last for nearly two decades. He drove up to meet me and got a look at how our head office functioned. My partnership, Kinko's Graphics Corp., was still handling all the books for the partners for a low monthly fee. It wasn't the greatest structure. We were getting by, but we could do better. Later, John turned up at one of our partner meetings. He sat in the back, scribbling enigmatically into a small red notebook. Here's John:
[BOOKS_excerpt_Orfalea_headshot]
California Polytechnic State University, San Luis Obispo
Paul Orfalea

"In my field we learn about organic organizations, but I think it's fair to say that I'd never seen, at that point and subsequent to that time, an organization that was quite so organic. Things just happened as they needed to happen, or maybe a little later than they needed to happen, but they happened. There didn't seem to be a plan. There didn't seem to be a structure. There didn't seem to be much of anything, but a lot of things were getting done at the right time. It was fascinating to me. I felt like an anthropologist trekking through the jungle and kind of stumbling on this tribe that I had never seen an example of before. I had never seen organic Republicans. They were really interesting creatures. They were capitalist hippies, really. It was bordering on strange. You can only be so organic without defying the public health laws, right? The growth of this company and the growth of the people was clearly managing to outstrip any reasonable attempts to provide logical, sane infrastructure to the company. There were costs to it, but it was part of the magic of the company."
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At the end of that first partners meeting that he attended, everyone was curious to know who this scholar in our midst was, taking notes and saying nothing while the rest of us argued, pontificated, and generally exercised our democratic rights. Eventually, John took the microphone and shared some of his observations about what he saw in us and in Kinko's. He told us he saw us moving toward a more formal organization, but he saw us doing it in our own "organic" way. He made us laugh. We liked him. We liked what he had to say.

Over the years, he came to play a variety of roles at the company. He started as an outside consultant and eventually became a full board member, a position he held for ten years. He also served as, variously, educator-in-chief, peacemaker, resident shrink, and company philosopher. As my partner Tim remembers it, "We had to start growing up once John Davis became involved. He realized we were struggling with late adolescence. We didn't yet realize that commitment and hard work could go a long way. He had a fabulous influence on us." A lot of our partners were somewhat like me. We got things done, but we couldn't talk about what we were doing with the sort of context and eloquence that John brought to bear in any discussion. He became our spokesman. He helped us to communicate better with each other and with the outside world.

John noticed our tendency to philosophize right off the bat. "At that first partner meeting," John says, "they were all just sitting around talking about their business not just in financial terms and marketing terms, but in philosophical terms as well. It was like being on the set of The Big Chill. These people didn't go to college together, but it was almost like they did. And even though Paul played the role of paterfamilias he was basically just the big brother. He encouraged very collegial relationships, buddy relationships."

Two years later, in 1985, John decided he would put our proclivity for debate and discussion to work for us. He made a suggestion. John felt strongly that we needed to write down a set of guiding principles to unite our far-flung factions, giving us a flag to rally around. We took John up on it. We decided we would go ahead and try to put something on paper about who we were and who we wanted to be. John drew up the first draft and derived the content from what he'd observed in us for two years. The result came to be called the "Kinko's Philosophy." Like so many of our best ideas at Kinko's, this one originated not with me, but with someone from the outside who, by virtue of being undistracted by being in the business, was able to offer some valuable insight. We spent six months hashing out the Philosophy, and then continued to revise it over the years. The final version read as follows:

Kinko's Philosophy

Our primary objective is to take care of our customers. We are proud of our ability to serve him or her in a timely and helpful manner, and to provide high quality at a reasonable price. We develop long-term relationships that promote mutual growth and prosperity. We value creativity, productivity, and loyalty, and we encourage independent thinking and teamwork.

Our co-workers are the foundation of our success. We consider ourselves part of the Kinko's family. We trust and care for each other, and treat everyone with respect. We openly communicate our accomplishments and mistakes so we can learn from each other. We strive to live balanced lives in work, love, and play. We are confident of our future and point with pride to the way we run our business, and treat each other.

We plastered the Philosophy everywhere. We printed it up on small, laminated wallet-sized cards so that people could carry it around in their pockets. Some partners hung the Philosophy on the walls of their stores. Eventually, and even though it seemed hokey at first, we started reciting it at our partner meetings and picnics as if it were the Pledge of Allegiance. But we didn't view it as fixed in stone. The tenets of the Philosophy were inherently contradictory: even though we valued "independent thinking," we also encouraged "teamwork." The Philosophy became a tool for managing ambiguity, one of the most difficult challenges in any business. It provided a ready forum for discussions about how we would continue to grow and work together as individuals who were also members of a collective. As we changed, we constantly floated ideas for how to further hone, expand, or otherwise alter it. I was forever asking people, "Do you think we should change the Philosophy? How would you rewrite the Philosophy?" It became a mechanism by which everyone became invested in the direction of the company.

In the Judeo-Christian tradition, there are the Ten Commandments. We may not abide by all of them all of the time, but they are there to guide us. Every company should take the time to write a philosophy statement. One of my favorite companies, Johnson & Johnson (also one of my longtime favorite investments), has a great one. I bought the stock after I watched a 60 Minutes piece on the infamous crisis during which eight people died from poisoned Tylenol pills back in the eighties. J&J decided that any response it made to the crisis would be true to its credo, which has guided the company through the past 60 years. The first sentence of that credo reads, "We believe our first responsibility is to the doctors, nurses, patients, to mothers and fathers and all others who use our products and services." In other words, covering their own butts is explicitly not priority number one of J&J's leadership. The company leaned on its own stated belief system in a time of need. J&J responded to the crisis quickly, with compassion and, in the process, won new loyalty from its customers.

Having a high-minded vision that we all embraced for Kinko's was immeasurably helpful. At least we knew if we failed to meet its ideals, we could get back on track and point ourselves in the right direction. As John puts it, "The Philosophy was the expression of the ideal culture. But it was our goal. It was what we wanted." The only limit to your growth as a person or a company is your imagination. When you think about it, there are only two things in life: matter (cars, sidewalks, bodies, etc.) and ideas. These are the only two things on Earth. (In fact, scientists now believe that, at the subatomic level, there is really no significant difference between matter and thought; in other words, our thoughts truly create our reality. Isn't that cool?) The way I see it, you're only as good as your dreams. If all of us at Kinko's could imagine an ideal place where we could all work together, we had a shot at achieving it and much of the time we did.

Envision Your Vision

Having a vision is beneficial in the private, not just the corporate, realm. Early in my time at Kinko's, I took a class on goal setting at the University of Virginia, but goal setting has always been in my blood. Picturing myself owning my own business one day helped me to navigate through my difficulties in the second grade. Even as Sister Sheila paddled me, I told myself that someday I would own my own business and have secretaries who would read for me. By the time Kinko's was up and running, I made a habit of setting new goals every six weeks or so. Wherever I went when I was with Kinko's, I carried a four-subject notebook. I didn't write long letters or reports, of course, but I did make lists. The notebook was full of them. I was an inveterate list maker. I set personal goals. I set play goals (every January 1, I scheduled my blocks of vacation for the year). I set business goals. I set financial goals. I worked out the cash flow for Kinko's in one section of the notebook. I always say that if you don't know your business well enough to calculate your cash flow on the back of an envelope, you've got problems. My coworkers were constantly criticizing me for having too many top-priority items to attend to. It was tough for me to stay "on" my business while addressing so many priority issues. So I classed them as Big, and then Big-Big, and, finally, Big-Big-Big. It sounds corny, but it worked for me.

At the end of our family vacations, or any business trips, I became maniacal about getting my lists in order. Before I headed back to work, I got to work on these lists. Completing them could take me the better part of the day.

I quickly learned not to be too specific in putting my goals onto paper. I remember one time in 1975 I set an arbitrary goal for myself to open three new stores between September and December. In order to open store number three, I pushed too hard. The store, in Westchester, California, turned out to be one of our worst locations ever. We constantly clashed with the landlord at that site. Eventually, we closed it. I've since learned that goal setting should be more like an impressionistic painting. As opposed to "Open three new stores by the end of the year," my goal became simply "Expand the business." Keep your goals as anchors and then wander around among them, giving yourself plenty of room for error and experimentation. I used to sketch the following illustration for my partners back in my twenties. You start with some clear goals. Here they are represented by two straight lines:
[parallelLines.gif]

Then you allow for a little spontaneity. You wander around among them. Like this:
[dollarSign.gif]

Ta-da! See what you end up with? Know where you're going, but don't be too wedded to the result. My friend John Davis used to say, "The best part about goal setting is going through the process. First make your plan, and then throw it out!" Remember that line from the old musical South Pacific, "If you don't have a dream, how you gonna make a dream come true?" Good question. I love to sing that line to my partners from time to time. As far as I was concerned, the Philosophy was our strategic plan. It was the expression of our collective dreaming at Kinko's. We each need to do our individual dreaming as well.

Living It

The more we recited the Philosophy and embraced it as something real, the more it became, over time, something we held very close to our hearts. Some of our former coworkers have imported modified versions of it into the new companies they started after leaving Kinko's. I carry a copy of the Philosophy around with me on one of those laminated cards and still find myself having reason to pull it out and refer to it.

At every picnic and partner meeting, someone was chosen to go to the front of the room and recite the Philosophy at the microphone for the rest of us. It could be someone who had made a pioneering change or someone who had survived hardship. One year it was our partner in Chicago, Theresa Thompson, the first of us to take her stores to a 24-hour schedule, who led us at the mike. Other times, Karen chose a partner who had recently struggled through a trying time. My partner Todd Johnson was only 30 and had been working with us for eight years when his young wife died suddenly in 1984 from an aneurysm. She was 28 years old and pregnant with their fourth child. Doctors managed to save the infant but couldn't save her. She died a month before Natalie and I were married. I'd gotten to know Todd and his family well over the years so I flew out to them after it happened. He was planning on coming out to Santa Barbara from Utah for our wedding anyhow. I told him to bring his kids and stay at our place while Natalie and I went on our honeymoon. At a partners meeting about a year later, Todd read the Philosophy out loud to everybody. In the midst of all the general zaniness and uproar that accompanied most of our company meetings, moments like these were powerful.

Todd: "Reading the Philosophy made it more than a written philosophy. It became a living philosophy. I've never been great verbally, but the first time somebody laid out the Philosophy, I thought, 'That's exactly how I feel.' You heard it all the time. When Paul picks up on something, he's relentless. It became a way of life in the stores. At first, when we recited it, I kept thinking that I felt like I was working for Amway, but I knew that Paul believed in it. When someone practices a belief system in his life, you can see it. It was Paul's own philosophy and he promoted it to the point where it became everyone else's philosophy."

If you flipped over the small laminated card that was printed with the Philosophy on one side, you would find a list of guiding principles. These are the "Kinko's Commitments to Communication."

There were 14 points, with a final add-on at the end:

1. I will recognize your value to Kinko's.
2. I will share my goals with you, and together we will develop an action plan.
3. I will respect and utilize the chain of command to resolve problems.
4. I will solicit immediate feedback to assure we understand each other.
5. I will talk with you, not at you.
6. I will listen with an open mind.
7. I will try to see the situation from all points of view.
8. I will tell you when I don't know the answer, and together we will seek the answer.
9. I will give you honest and sincere feedback.
10. I will not usurp your authority.
11. I will not confront you when I am angry.
12. I will not gossip.
13. I will not publicly embarrass you.
14. I will admit when I am wrong.
. . . and in every case, I am worthy of the same from you.

I wish I could tell you I abided by each of these tenets all the time myself, but I'm a human being and we were a company of human beings. I always figured when we hired someone, we got the whole enchilada. That applied to all of us. I plead guilty to personally violating many of these tenets. But, just because I fell short myself from time to time doesn't mean I underestimate their importance. Our partner David Vogias, who owned and ran stores in Ohio, Pennsylvania, New Jersey, and New York, was the driving force behind the Commitments to Communication. Dave felt we needed the commitments to further define how the Philosophy should be implemented—to make sure it was being implemented. The truth is, Dave and I argued so much that he proposed the commitments as an effort to lay down the rules of engagement between him and me. The commitments weren't passed by all the partners. They were passed in a committee of which Dave was a member. As Dave remembers it, "I forced the Commitments to Communication."

Looking back I should have argued more to change some of these commitments. Number 12, for example: "I will not gossip." What does that mean, really? I never understood that one. How can we function as a community and a family if we don't talk about each other? Talking and learning about each other is one of the great pleasures in life. I think that commitment should have read, "I will not engage in malicious gossip." You can see how much debate these value statements can inspire. In retrospect, I would have also instituted a values statement covering all meetings. It would have stipulated that, when it comes to meetings, everyone in attendance would (a) arrive on time, (b) understand what the purpose of the meeting is, and (c) seek together to find a conclusion so that the meeting could end—and end quickly.

Nitpicking aside, the Commitments to Communication further refined some of the practical ways we sought to live by the Philosophy.

As we grew, we came to rely on the Philosophy in more concrete ways. By the late eighties, we began circulating anonymous coworker surveys to determine whether the Philosophy was being applied in all our stores. We used the Philosophy to devise a set of criteria that we used to evaluate coworkers. As we matured as a company, our president, Dan Frederickson, instituted a program of management effectiveness surveys and, later, 360-degree reviews wherein coworkers at the head office, Kinko's Service Corp., were evaluated by their colleagues, by the people who reported to them, and by those they reported to. From all directions, coworkers evaluated each other against the principles we'd voted on and laid out together in the Philosophy.

Before coming to Kinko's, our partner Gerry Alesia had worked at Ralph's Grocery Co., General Foods, Bally's, and Ramada and he hadn't come across anything like the Philosophy. "It was very unusual," Gerry says. "It took several meetings for us to write and there was a lot of fighting about the individual words. We pretty much lived and believed what the Philosophy said. We believed that the coworkers were the foundation of our success. It wasn't just lip service."

The fact that we shared a belief in a set of fundamental principles and tenets made it, paradoxically, easier for us to tolerate conflict. I've always loved controversy and debate. I believe it's necessary for a healthy company, indeed, every healthy relationship.

Here's my partner Mark Madden, "Paul and I once met with a real estate guy in Santa Barbara. He asked us what the perfect size was for a Kinko's store. Paul said about 8,000 to 10,000 square feet and I said about 4,000 square feet. Obviously, quite a difference. We debated with each other a few minutes and then looked up, a bit embarrassed that we couldn't even agree on the size of a store. The guy got a huge kick out of seeing us debate basic business principles. He was used to seeing a boss and a bunch of yes-men and -women who would never disagree with the leader. He loved that Paul was the one pushing for a bigger, longer-term opportunity, while I was the one pushing for moderation and improved short-term profitability."

We all did business differently. Take my partners David Vogias and Tim Stancliffe. Dave, who ended up with 50 stores, admired and sought to emulate big blue-chip companies like General Electric. He ran his company with many more levels of bureaucracy than I would have. And yet, the policy manual that his company wrote up for one of our core businesses, Professor Publishing, ended up being adopted by most of the other partners. I hate policy manuals myself. Obviously, I'm never going to spend free time reading them. But, if our other partners could make use of one, I'm glad Dave got it written. He loved concocting five-year strategic plans—an activity I find pointless and unbearable. In contrast, he thought my stores were loosely and poorly run. I repeatedly told him that he could have expanded his business ten times faster were he not so wrapped up in tending to all that bureaucratic mumbo jumbo. Then there was Tim, who owned stakes in about 170 stores in Colorado and surrounding states. Tim was so frugal with his money that, in my view, he never invested enough of his profits in testing new ideas. Tim didn't protest this view of his management strategy because he liked to put new products through a lot of testing and careful consideration before using them. Tim: "No-new-products-Tim was one of my nicknames. I reveled in that kind of attention." As a result, he was never on the cutting edge of adopting our newest innovations. This meant that all the Kinko's locations in one entire corner of the country lagged behind other regions. We constantly argued about our different views of the world and of business.

Simply put, we didn't treat each other with kid gloves. We knew we didn't have to. We could stand a little controversy and trust we'd emerge the better for it. Having a shared philosophy gave us resilience.

As John Davis observed, "The Philosophy became a fundamental aspect of the Kinko's religion. When somebody stood up and recited the Philosophy at the end of each meeting, it was like a recitation of the Nicene Creed [a doctrine of Christian faith adopted in a.d. 325]. It was 'This is who we are.' People really understood that the strength of the group came from the ability to speak openly about things and to challenge each other. It was a culture of being open and honest. You could go through really turbulent meetings where there was yelling and arguing and some harsh things said, and at the end of the meeting, we would recite the Philosophy together. And it was OK."

Excerpted from "Copy This! How I Turned Dyslexia, ADHD, and 100 Square Feet Into a Company Called Kinko's" by Paul Orfalea. Copyright © 2005, 2007. Used by permission of Workman Publishing Co. Inc. All Rights Reserved.

Shrinkage problems-monitoring employee theft

For small businesses, preventing theft and fraud by employees can be an uphill struggle.



Unlike their big counterparts, small companies usually can't afford a large security staff or big-ticket monitoring technology to keep an eye on things. And they often don't generate enough sales volume to make up for the losses from pilfering.
WSJ's Raymund Flandez reports how grocery stores and retailers are waging a continuous battle against employee theft. He discusses "sweethearting," an unauthorized giving away of merchandise.

Now a new generation of security technology aims to give small businesses an inexpensive defense against unscrupulous employees. Some of these systems let business owners who are on the road check their security cameras over the Internet and get email alerts if something unusual happens, such as employees closing up shop early.

Restaurants, meanwhile, can use tableside credit-card readers to prevent cashiers from stealing customers' card numbers or inflating the tips written on bills. And grocery stores can use a combination of security cameras and software to automatically spot cashiers who try to slip free products to their friends and family.

These new products are arriving as stores face mounting losses from theft. According to the latest National Retail Security Survey, losses from "shrinkage" -- which includes theft, fraud and error -- reached a new high of about $40.5 billion in 2006. About half of that -- $19 billion -- came from employee theft. Shoplifting, in contrast, accounted for about a third. (The study, conducted by the University of Florida and the National Retail Federation, was funded in part by grants from makers of security systems.)

Here's a look at some of the most innovative new security systems out there.
TROUBLE IN STORE

• The Situation: Theft can mean disaster for a small business, wrecking its profit margins and hurting its reputation.
• The Trouble: Small businesses often can't afford the big-ticket security solutions big companies favor.
• The Way Out: A host of new technologies are filling the void, giving small operators a way to protect their businesses on the cheap.

WATCHING FROM AFAR

For a small-business owner worried about employee theft, leaving the shop in someone else's hands can be nerve-wracking. Now a host of security providers let bosses check in on things from the road.

For instance, Alarm.com Inc., of McLean, Va., sells a system that allows owners to travel to a Web portal and get remote feeds from security cameras, change entry codes and trigger sensors that monitor systems such as lighting and climate control. If a problem arises with those systems -- such as a power outage -- you can get an alert via a text message or email.

Recently, Kevin Donahue, owner of a Planet Beach Franchising Corp. location in McLean, was in Amsterdam on business when he received a text message from Alarm.com: The spa's alarm system had been armed at 3 p.m., before the usual closing time. He checked the security cameras online and saw the facility was dark.

So he called his manager and got the explanation: The spa had closed early because of a snowstorm.
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"The greatest thing is that it gives me the ability to travel and do the things that I do," says the 34-year-old Mr. Donahue, who's also a full-time salesperson for a tech company and often travels outside the country on sales trips. "It gives me the ability to manage my staff remotely. I can call and say, 'What's going on?' "

Mr. Donahue bought the system for under $100 and pays a monthly fee of $39. Alarm.com says the base price for the system is usually $500, with a monthly fee of $29 to $50, although those numbers can vary by reseller and area, as well as the features customers choose.

SAFEGUARDING CARDS

Another new technology helps small businesses -- particularly restaurants -- protect against "skimming." In this scam, cashiers steal customers' credit-card information for use in identity theft.

About 70% of credit-card-fraud cases involve skimming, according to Trustwave Holdings Inc., a data-security and compliance-management company based in Chicago. In many cases, business owners are ultimately held responsible for their cashiers' crimes -- costing them money and damaging their reputation.

For some businesses, the solution is to let customers become their own cashiers. At Southeast Grille House in Brewster, N.Y., servers bring a wireless gadget called On the Spot to their customers' tables. Patrons can swipe their credit cards on the device -- which is about the size of a brick -- punch in the tip amount and print out a receipt to sign, all from their seat.

Since the customer enters all the information, cashiers can't inflate the tip -- and the receipts don't contain much personal data that could be stolen and used for identity theft.

The device, from VeriFone Holdings Inc. of San Jose, Calif., runs about $1,000. Southeast Grille House owner Domenic Chiera says it was worth the investment. "It's fast, and the receipt has little information, so no names or numbers," says the 57-year-old restaurateur. "I like the system. It works well for us."

CHECKING OUT FRAUD

At grocery stores, thieving employees are almost as much of a problem as shoplifters. About 40% of grocery-store thefts were attributed to employees in 2006, according to the Food Marketing Institute's Supermarket Security and Loss Prevention 2007 report. One of the biggest problems is "sweethearting," in which cashiers give friends and family freebies by pretending to scan items at the register.

Many stores use closed-circuit television to watch checkout lines. But the stores often don't have the time or manpower to review the tapes, so the cameras aren't a strong deterrent. StopLift Inc. of Bedford, Mass., has devised a system that combines cameras with advanced software to spot sweethearting automatically. The technology can recognize when cashiers make unusual movements when handling items -- such as placing a hand over a bar code -- and determine whether the items were properly scanned.
[SECURITY_sweethearting]
Courtesy of the company
'Sweethearting' theft in progress as seen in a StopLift video

When the system identifies sweethearting, it places blinking squares over the video to show exactly where the theft occurred. Then it gathers the incriminating clips together for owners to review.

Stores "have the cameras but they don't have the manpower to watch it," says Malay Kundu, chief executive of StopLift. "What we've done is sort of automate that."

Three Big Y Foods Inc. stores in Massachusetts and Connecticut have been testing StopLift's Checkout Vision Systems for the past five weeks. Mark Gaudette, director of loss prevention at the Springfield, Mass., grocery-store chain, suspects that employee theft accounts for about 38% to 40% of its total losses.

"We've got pretty much a zero-tolerance policy for any folks that steal," Mr. Gaudette says. "What we're hoping is that all these technologies will help us in loss prevention and educate all of our staff."

The stores had already been using closed-circuit television and software that scrutinizes sales data for abnormal behavior or inconsistencies at the cash register, such as excessive voids or refunds. But those measures weren't enough to stem the losses.

StopLift's system works with those tools to ferret out sweethearting. For instance, if the sales-data software shows that somebody rang up too many coupons on one order, the StopLift system can analyze video from the exact moment this happened.
[losses from theft chart]

Big Y is still analyzing the results. So far, Mr. Gaudette says, he has spotted some sweethearting incidents, but he has seen far more cashier errors, such as giving up on hard-to-scan items instead of calling the manager for help.

Pricing for the technology is done on a case-by-case basis, says StopLift's Mr. Kundu. He says that for a typical medium-volume store, monthly subscriptions currently run about $2,000.

Of course, buying these systems isn't the only option available for small stores. Experts suggest that stores could hire fewer part-timers -- who have less attachment to the business and are more inclined to steal -- and conduct more-rigorous pre-employment screenings to weed out potential thieves.

Employers must also hammer home a code of conduct, experts advise. For instance, give new hires talks on integrity and loss prevention and offer anonymous hotlines where employees can notify managers about fellow workers who may be stealing.

The bottom line is that employees must recognize they have a part to play in stopping theft, says Joseph LaRocca, vice president of loss prevention for the National Retail Federation. "Loss prevention is really everybody's responsibility," he says.