Case 11 Equal Exchange: Doing Well by Doing Good1 Rev. Dr. Benita W. Harris Asbury United Methodist Church Frank Shipper, PhD Perdue School of Business, Salisbury University Karen P. Manz Author and Researcher Charles C. Manz, PhD Isenberg School of Management, University of Massachusetts Vividfour / Shutterstock.com Introduction In 1983, Rink Dickinson, Jonathan Rosenthal, and Michael Rozyne were all recent college graduates and working for a food co-op warehouse in the Boston area. They began to question the system, asking questions such as, \"What if food could be traded in a way that is honest and fair, a way that empowers both farmers and consumers? What if trade supported family farms' use of organic methods rather than methods that harm the environment?\" Almost simultaneously, they started to hear about groups in Europe engaged in a concept called fair trade. The advocates of fair trade wanted to ensure that the producers of products such as coffee, tea, and chocolate would receive a better price for their crops while also providing support for improvements to their environmental, social, and political conditions. Dickinson, Rosenthal, and Rozyne liked the idea. According to Dickinson, they \"...were basically food co-op people, interested in connecting small, local farmers with consumers to change the marketplace,\" however, it was not their intention to found a company. Instead, they took the idea to the board of directors of the co-op warehouse. Half the board supported the idea and half voted against it. It became apparent to them that if they were going to pursue their vision, they were going to have to do it themselves. Over the next three years, they met once a month to develop their plan and raise the capital to establish their own organization. The three young entrepreneurs quickly learned that no institution - including organizations that specialized in high-impact social justice ventures - would lend them money. Thus, fundraising focused on family, friends, and their contacts. According to Dickinson, the general pitch was, \"We want you to invest in this project and it is almost guaranteed to lose all of your money.\" On those terms, they were able to raise $100,000. While raising money, Dickinson said they used their jobs to learn about cooperatives, small farmers, entrepreneurship, marketing, and \"making mistakes, right and left.\" The food co-op gave them \"a great environment to learn some skills.\" In 1986, Dickinson, Rosenthal, and Rozyne were ready to launch Equal Exchange (EE). By that time, their ambition was \"...to change the way food is grown, bought, and sold around the world.\" EE embarked on its pioneering efforts to sell fair trade products in the U.S. with coffee from Nicaragua. From the beginning, EE has paid its producers, typically small farmers indigenous to their region, an above market price for their products out of a desire to help provide a better, more stable income and to more equitably distribute the proceeds of the final sales. EE prominently displays the company slogan on each product - \"Small Farmers, Big Change.\" 119 CHE-HITT11E-13-0403-CaseStudy11.indd 119 22/10/13 2:47 PM 120 Part 4: Cases Not content to just \"...change the way food is grown, bought, and sold around the world,\" the founders of EE formally adopted a hybrid worker-owner co-op structure in 1990. They believed this ownership structure would make its employees feel valued and, in turn, they would invest their whole being in the organization. Key to this new structure was shared employee ownership. Each workerowner buys one share of Class A voting stock; no one did, could, or can own more than one share of voting stock. Worker-owners can also buy unlimited shares of Class B, non-voting stock. This structure distributes power, and potentially leadership, equally across all worker-owners on a democratic one-person/one-share/one-vote basis. 2012 Twenty-seven years later not only is EE doing good - it is doing well (see Exhibits 1 and 2). EE sales have grown from zero in 1986 to $1 million in 1991 to $42.8 million in 2010.2 In 2011, sales increased another 9 percent to $46.8 million and EE projected that sales would exceed $50 million in 2012. All EE products (coffee, tea, chocolate bars, cocoa, sugar, bananas, almonds, and olive oil) are fair trade and most products are organic as well. Co-Executive Directors, Rink Dickinson and Rob Everts and the worker-owners of EE are still interested in changing the world through socially responsible business. Its mission statement reveals the heart of EE: ... to build long-term trade partnerships that are economically just and environmentally sound, to foster mutually beneficial relationships between farmers and consumers and to demonstrate, through our success, the contribution of worker co-operatives and fair trade to a more equitable, democratic, and sustainable world. In 2006, EE announced, \"Our Vision in 20 Years... [To build] a vibrant, mutually cooperative community of two million committed participants trading fairly one billion dollars a year in a way that transforms the world.\" Functional Areas at EE To fulfill its mission and vision, the founders developed a hybrid model that combined worker-ownership with a cooperative model to coordinate the functions. EE is a relatively small company. With approximately 100 worker-owners and geographically dispersed operations, worker-owners may fulfill multiple functions. EE Governance Model EE has a board of directors that is elected by the workerowners. The worker-owners nominate candidates for the six inside board member positions and a joint, three- person committee - comprised of a worker-owner, a board member, and a member of the management c ommittee - nominates candidates for the three outside seats. The worker-owners elect all nine seats, three each year. In turn, the board of directors hires EE's Executive Director/s. Currently, the position is called \"The Office of Executive Directors\" as it is shared by Dickinson and Everts. They are mutually responsible for hiring employees Exhibit 1 Sales Growth $50,000,000 $45,000,000 $40,000,000 $35,000,000 $30,000,000 $25,000,000 $20,000,000 $15,000,000 $10,000,000 $5,000,000 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 $0 Source: This graph was constructed from financial data published by EE on the Web at http://www.equalexchange.coop/investing. CHE-HITT11E-13-0403-CaseStudy11.indd 120 22/10/13 2:47 PM 121 Case 11: Equal Exchange: Doing Well by Doing Good Exhibit 2 Profit/Loss (pre-tax) $1,760,000 $1,560,000 $1,360,000 $1,160,000 $960,000 $760,000 $560,000 $360,000 $160,000 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 -$40,000 Source: This graph was constructed from financial data published by EE on the Web at http://www.equalexchange.coop/investing. who, after significant input from the other worker-owners, may later become worker-owners themselves. It is important to note that the Executive Directors are not board members. According to Lynsey Miller, Market Development Leader and a former board member, \"They're at the board table, but they don't have votes. They are very active in that discussion and agenda setting.\" Thus, ultimately, the worker-owners who elect the board and hold two-thirds of the seats are responsible for hiring the Executive Directors. All members of the board serve three-year terms. Instead of electing a new board every year and to promote board continuity, two inside directors and one outside director are elected each year. This circular structure reinforces the following four concepts at the heart of the EE governance model: 1. the right to vote (one vote per worker-owner, not per share); 2. the right to serve as leader (e.g., board director, or other elected office); 3. the right to information; 4. the right to speak your mind. EE provides the following elaboration of this model on its Web site: A worker cooperative is an alternative for-profit structure based upon standard democratic principles. It is not designed to maximize profits, nor returns to investors, but rather to bring to the workplace many of the rights CHE-HITT11E-13-0403-CaseStudy11.indd 121 and responsibilities that we hold as citizens in our communities. These principles include one-person/one-vote equality; open access to information (i.e., open-book management); free speech; and the equitable distribution of resources (such as income) ... The delegation of responsibilities is very much like that of conventional firms - which allows for efficiency - except that at EE those at the \"bottom\" of the organizational chart are, as owners, also at the \"top\" of the same chart.3 Everts describes the genesis of this governance model as follows: From the beginning, it has been a culture in a context of participation and shared ownership of strong management. The founders were quite clear that ownership would be shared and that ultimately, accountability for the highest level decisions would be shared and that we would attempt to build a strong cultural of internal participation and democracy. There was no interest in having it be a collective. One important position in this governance model is the Worker-Owner Coordinator. The worker-owners elect this individual, but this person is not a board member. The Worker-Owner Coordinator has many duties, the most public and demanding of which is facilitating the cooperative meetings that are held at least quarterly. Overall, the Coordinator is often akin to a police officer directing traffic; he or she does not make the rules of the cooperative, but is empowered by the cooperative to keep the system 22/10/13 2:47 PM 122 moving smoothly so necessary work may be completed. To do this, the Coordinator directs the jostling interests, opinions, and emotions of the members as best he or she can. One goal is to strike a balance between members' rights to ask questions, be heard, and press for changes with maintaining a safe, respectful, and constructive environment. The Coordinator is automatically the representative of the worker-owners on certain \"tripartite\" committees, representing the board and management second. One example is the committee that nominates outside board members. The Coordinator also leads the 10-member worker-owner cabinet. The cabinet is a group of volunteers, accountable to the Coordinator. They carry out essential cooperative functions such as maintaining the internal education program and conducting the complex, multi-ballot, multi-site elections. A secondary function for the Coordinator is to give the \"State of the Cooperative\" presentation at the annual meeting in May. This presentation provides an assessment of how well EE is functioning as a cooperative, not as a business per se. The worker-owners can call a meeting of the cooperative by presenting signatures of 10 percent of the worker-owners to the Coordinator. If a worker-owner wants to bring something to an upcoming meeting and has either the Coordinator's consent or the required number of signatures, the Coordinator is responsible for putting the individual on the agenda and working with that person so that her/his idea is well thought out and presented. As can be seen by this description of the governance model, to be successful, EE must negotiate complex communication and coordination processes. Thus, recruiting, selecting, hiring, developing, and retaining employees who can operate within this governance model and flex with the needs of the organization is critical. Human Resource Management The worker-owners focus considerable attention on human resource management because, with the ownership culture that exists on a daily basis, worker-owners must be a good fit. Recruitment is probably EE's area of least worry. Whenever it does advertise an open position, it has multiple applicants. Because of its reputation, primarily spread by word of mouth, EE has no problem obtaining a significant and qualified applicant pool. The hiring process, outlined in Exhibit 3, is quite extensive and considered critical to the success of EE. Two unusual aspects of the hiring process include a three-stage interview and the fact that the hiring process is not considered complete until after the review process and after the new hire has been on the job for three months. CHE-HITT11E-13-0403-CaseStudy11.indd 122 Part 4: Cases Once hired, new employees are matched with a mentor and put on probation for one year. New employee turnover during the first year is approximately 5 to 10 percent. After the first year, all worker-owners vote on whether to offer worker-ownership status to the employee (i.e., the opportunity to join the cooperative). Before the vote, the employee's mentor and the employee's supervisor circulate written statements on behalf of the candidate. With rare exceptions, only new employees who have fared well reach this point; new hires that have been poor employees or seem ill-suited for the co-op are generally weeded out by this time. Almost all worker-owner candidacy votes are taken online, but current workerowners may also request an in-person meeting for a discussion and vote. In such a case, all worker-owners are free to discuss the individual's fit with EE before taking the vote. Worker-owners can vote \"yes,\" \"no,\" or \"abstain.\" Unless 20 percent or more worker-owners vote \"no,\" the candidate is welcomed into the co-op. Over 95 percent of employees who make it to the one-year point are accepted as worker-owners. Because of its infrequency, when one is not accepted, it can be a traumatic event for all. During the probation period (first year of employment) the employee is expected to participate in a curriculum designed to teach about the mission and vision of EE, how they work, and to prepare the candidate for the responsibilities of worker-ownership and governance. The worker-owners feel it is very important to develop Exhibit 3 Outline of Hiring Process I. Executive Director Determines Need for Position II. Executive Director and Chair of Hiring Committee Agree on Process III. Hiring Committee Develops Tactics IV. 100 Point Rating System (20 points for each category) a. Fit (mandatory) b. Team (mandatory) c. Communication (mandatory) d. Option 1 (e.g. skills, aptitudes) e. Option 2 V. Recruiting a. Defining Target Applicants b. Internal Posting c. Networks d. Previous Applicants e. External Advertising VI. Essay Questions VII. First Round Interviews - Conference Calls with Committee VIII.\tSecond Round Interview - In Person, or by Phone IX. Third Round Interview - In-person Interview X. Reference Checks XI. Offer Letter - Delivered by Mail for Signature XII. Three Month Review Source: Condensed from company documents, 2005. 22/10/13 2:47 PM 123 Case 11: Equal Exchange: Doing Well by Doing Good and strengthen its worker-ownership culture. To support the development of the culture, EE has developed an Owners' Manual that is over two hundred pages in length. To both support this effort for new employees and to reinforce the worker-ownership culture for all, \"Exchange Time\" is held every Thursday morning for one and a half hours. Exchange Time lectures and discussions cover topics such as fair trade, co-op history, and issues affecting EE's farmer partners, among others. New employees are essentially required to attend while all other employees are encouraged to participate. The discussions are recorded and shared with remote employees and regional offices via EE's intranet. Cody Squire, who joined EE right out of college a few years ago, enthusiastically described Exchange Time as: It's one structured thing that you can depend on having every week just to learn about something new, to look deeper into something you already know about, or to hear from somebody who has just returned from working with farmer co-ops in Peru. In addition to Exchange Time, EE has \"10 percent time.\" Employees can use 10 percent of their work time for purposes unrelated to their core functions. This time can be used to cross-train, work on governance committees, or learn more about EE's products. For example, Miller used her 10 percent time to serve on the board of directors, where she helped create the 20-year vision for EE. Mike and his colleague in Quality Control, Danielle, led a program called \"The Brew Crew,\" a year-long curriculum on coffee. People from other departments participate in coffee quality trainings every two weeks for a year. To develop future leaders, EE uses an unusual 360 degree peer evaluation process in which peer, subordinate, superior, and self-evaluations are performed. The unusual aspect of EE's process is that all who provide feedback must sign their forms. In other words, the feedback is not anonymous. Alison Booth, Manager of EE's espresso bar in Seattle, Washington, described how it worked for her: If I'm being evaluated, my supervisor and I will have access to them... Sometimes they are just nice to hear, but not terribly helpful; sometimes they're a little hard to hear. Most of the time, people are really careful to give constructive criticism, to give specific examples of things we could do better or things we did well. Then, I do a self-evaluation and my boss does a supervisor's evaluation. He combines his thoughts with my evaluation and the peer evaluations and pulls them all together. We talk about what's working, areas for improvement, and what to focus on in the next year. CHE-HITT11E-13-0403-CaseStudy11.indd 123 To further increase intellectual capital, EE maintains a library to which all employees have access. Mike described the library as, \"Awesome ... it's full of DVDs and books on anything from economics to feminism to fair trade to....\" The worker-owners also have responsibility for the education committee, originally a board committee. EE identifies education as a \"... vital function. In shifting accountability for this committee, Worker-Owners became more accountable for their own education and the orientation of new employees to our co-operative.\"4 The worker-owners staff many roles in this model and share in both profits and losses. Because EE operates as a worker cooperative, profit sharing is referred to as \"patronage.\" \"Patronage\" is a common term used in cooperatives where co-op members receive a share of the profits, or bear a portion of losses, based on the extent they have participated in the co-op. At EE, all workerowners who have worked a full year receive the same amount without regard to rank or seniority as all contributed the same amount of labor time. The total potential patronage distribution consists of 40 percent of net income after state taxes and preferred dividends are paid. Half of this distribution is reinvested in EE, and half is paid in cash. In years of losses, the Patronage rebates are charges against the retained distributions. In terms of benefits, EE \"is generous\" according to Brian Albert, EE's Chief Financial Officer who joined EE after approximately thirty years with some well-known international firms. For example, it offers all employees twelve sick days each year. A worker-owner can use them for him/herself, to take care of a sick child, to attend a doctor appointment, or to spend time with a sick parent. Additionally, all worker-owners receive two weeks of vacation for the first two years. After that, they receive four weeks. After their eighth year, they receive five weeks. In addition, employees receive the standard holidays including the Friday after Thanksgiving. EE is also generous in the area of pay, paying above average for novice level jobs, but below average for senior level management positions. It maintains a topto-bottom pay ratio of four-to-one. It clearly states on its Web site that EE adopted this ratio to reflect the fair trade ethic inside the corporation. Production EE has not been content to be a single-product company. Its four major products and their percentage of sales are coffee (80.1 percent), chocolate (16.1 percent), tea (2.7 percent), and snacks (1.1 percent). Snacks include products such as Organic Tamari Roasted Almonds. 22/10/13 2:47 PM 124 Part 4: Cases In 2010, EE increased its stake in Oke USA, an importer and seller of organic bananas, to 90 percent. Oke USA sales were $4.4 million in 2010. In 2011, EE introduced organic olive oil. Ninety percent of EE's coffees are certified organic and 100 percent of its tea, cocoa, chocolate, sugar, and bananas are certified organic. To produce organic coffee, chocolate, tea, and its other products for sale to others, EE first secures the raw materials. The producers of these products come from around the world. EE buys raw product from four continents - North and South America, Africa, and Asia - and almost exclusively from developing countries (see Exhibit 4). For example, coffee is grown largely in developing countries and is often the second most valuable commodity (after oil) exported by them, according to John M. Talbot, a sociology professor at the University of the West Indies in Jamaica.i The large multinationals typically buy their raw materials from either large plantations or large sellers of coffee. The large sellers depend on middlemen, often referred to as \"coyotes,\" to buy coffee from small growers. According to an article in the April 25, 2011 issue of Time magazine, Ugandan coffee farmers receive 0.66 percent of the retail value of their product. In contrast, the U.S. Department of Agriculture estimated that U.S. farmers receive 12 percent of the retail value. EE buys directly from cooperatives that represent small producers, thereby helping these co-ops to internalize the activity and profits formerly captured by the middlemen (see comparison of supply chains in Exhibit 5). EE buys raw materials from over forty small farmer cooperatives in twenty-five countries at prices higher than typical. In its 2009 annual report, EE defined it sourcing standards as: Quality - Find the best beans. Flavor - Select sweet beans with unique flavor characteristics. Farmer Partners - Trade with small farmer cooperatives that share our vision of community empowerment. Direct Relationships - Import directly from farmer co-operatives. Fair Price - Pay above the market price, often above fair trade prices. Environment - Support sustainable agriculture, the preservation of sensitive areas, and reforestation of degraded land. Commitment - Source all our coffee according to the quality of the beans and the quality of the source. EE supports the cooperatives with both financial and technical assistance. In its 2008 Disclosure Document to Sell Class B Preferred Stock, the relationship with small farmers was described as follows, \"Our Commitment: we pay a fair price to the farmer, trade directly with democratic co-ops, supply advanced credit, and support sustainable agriculture.\" In other words, EE goes beyond just paying a fair price; it pre-pays on its contracts with the cooperatives. It also provides assistance to the cooperatives to ensure they can provide a high quality product. Mike Mowry, a quality control specialist, described what he did on a trip to Nicaragua as follows: We do a lot of work going down and actually training about quality. Even with their quality departments, we do extensive training on how to roast samples and how to cup coffee.5 The whole idea is collaborating with their tasters and our tasters. Exhibit 4 Where EE Buys from Small Farmers by Country, 2010 U.S. Mexico Guatemala Panama Ecuador Peru Bolivia Paraguay EL Salvador Nicaragua Dominican Republic Colombia Ethiopia Uganda Tanzania India Sri Lanka Sumatra South Africa Source: Information taken from EE Web site at http://www.equalexchange.coop/farmer-partners. i. Cacao, the key ingredient for chocolate, is also only exported by developing countries. CHE-HITT11E-13-0403-CaseStudy11.indd 124 22/10/13 2:47 PM 125 Case 11: Equal Exchange: Doing Well by Doing Good Exhibit 5 EE versus Conventional Supply Chain EQUAL EXCHANGE COFFEE CHAIN SMALL FARMER EQUAL EXCHANGE FARMER CO-OP CONSUMER STORE OR CAFE CONVENTIONAL COFFEE CHAIN SMALL FARMER PROCESSOR/ EXPORTER MIDDLE MAN COFFEE COMPANY U.S. BROKER STORE OR CAF FOOD DISTRIBUTOR CONSUMER Source: EE pamphlet. EE maintains that \"great\" coffee can be obtained from many sources. What sets it apart is that it buys \"great\" coffee from \"great\" sources. EE also provides assistance to the small farmer coops beyond food products. For example, it has provided assistance for training programs for women in Guatemala, an ecotourism project in Nicaragua, and new classrooms in El Salvador. When all of the sourcing standards work well, quality product is shipped to EE for further processing. However, sometimes EE has to break off a relationship with a co-op for either quality-control reasons or compromised governance of the cooperative, such as not living up to expectations of accountability, transparency, and democratic governance. Another difficulty with attempting to reach EE's production standards is illustrated with its history of bringing tea to market. In the 80s, when EE consisted of a small staff of five or six, tea was typically grown on large plantations; obtaining the product from small farmers was difficult. When EE first imported tea during the late 80s, the tea came from Sri Lanka and was a generic tea that may not have been from small farmers nor fair trade. At that time, there were no \"fair trade\" standards for tea; that would come later. However, EE did know the exporter, an exemplary, grassroots, non-profit, self-help organization called the \"Sarvodaya movement.\" It still operates today. In fact, it was one of the key players in relief and reconstruction after the 2004 Indian Ocean tsunami. At that CHE-HITT11E-13-0403-CaseStudy11.indd 125 time, working in solidarity with this locally rooted, progressive, self-empowerment organization - that would also receive a sizable portion of the tea profits - was the moral equivalent of \"fair trade.\" Unfortunately, that trade link was lost after approximately three years due to interruptions caused by the Sri Lankan civil war. Around 1997, EE made a second attempt at procuring tea from a region of India famous for tea, Darjeeling. By then, formal fair trade standards had been created for tea. To EE's dismay, the standards focused on plantations. Even so, EE plowed ahead. A major hurdle for EE lay in the fact that there was no tea available that was fair trade certified and organic and high enough quality for EE's market and from small farmers. The market demanded the first three criteria, but not the fourth, which happened to be the most important to EE. With the help of key, even \"ironic,\" allies in Darjeeling and Germany, EE began to create a path the firm thought gave it the best chance to eventually deliver a tea with all four characteristics. Rodney North, Spokesperson for EE, characterized its most important ally as \"ironic\" because it was a big tea plantation called TPI. In fact, it had been one of the model plantations for fair trade tea certification. The owners of TPI, the Mohan family, shared EE's aspirations to bring small farmers into the fair trade system. Thus, in the early years, 50 percent or more of the tea EE imported was from the TPI estates and TPI gathered the other 50 percent from co-ops of small farmers around them. TPI also assisted these co-ops with 22/10/13 2:47 PM 126 Part 4: Cases organic certification, fair trade certification, rehabilitating their tea bushes, and improving quality. Over time, TPI shifted its tea blends to include an increased percentage that was sourced from small farmers. After many more evolutionary steps, today, EE has a line of twelve teas. Ten are 100 percent small-farmer tea leaf. The other two are neither small-farmer sourced nor traditional estate - that is because one, the mint, is sourced from a U.S. farm, and the other, chamomile, is from an exemplary philanthropic Egyptian NGO (nongovernmental organization) farm entity called SEKEM. \"BUT, it is only a temporary source until we locate a suitable fair trade certified co-op of organic, small-scale chamomile growers,\" asserts North. When EE receives its products in the United States, additional processing may have to be performed. Coffee has to be roasted, tea packaged, bananas ripened, and chocolate processed. Then, the product has to be marketed and distributed. Marketing and Distribution EE uses multiple channels to market and distribute its products: (1) retail outlets, (2) an interfaith network, (3) schools, (4) the Internet, and (5) EE cafs. Retail outlets - including health food stores, food co-ops, bythe-cup shops (i.e., cafs and restaurants), universities, and chain stores - account for approximately 72 percent of sales. The consumer-owned food co-ops were EE's first sales channel and remain the largest sales segment. In contrast, selling to the larger grocery store chains has proven particularly difficult because, as the former Director of Marketing explained: It is tougher to succeed in that channel, because we don't have the marketing dollars that major food companies have, and that's been something that's been a struggle to try to figure out how to succeed because you need to have a national brand awareness, which is really tough to do on a small budget. Thus, EE developed some unconventional promotional strategies. In fact, Miller referred to them as \"guerilla marketing.\" She described some of the marketing in the early days: We would go out on the streets of Boston handing out coffee samples and when the police would come over to ask if we had a permit, we'd try to get them to have a coffee sample because we didn't get permits; kind of have to think on your feet and talk your way through challenges. Another guerilla marketing tactic EE uses is grassroots events. Beside traditional in-store product demonstrations, EE staff members participate in public speaking events, organize consumer letter-writing campaigns to ask supermarkets to carry its products, and even go door-to-door to get its message across. Another example of EE's use of guerilla marketing is the type of coupon shown in Exhibit 6. The interfaith channel is EE's second largest distribution channel with approximately 20 percent of sales. Exhibit 6 Exclusive Coupon EXCLUSIVE ONLINE COUPON FOR THE EQUAL EXCHANGE CASE STUDY Sample Equal Exchange's organic, Fair Trade products for yourself and save 10% off your order at our retail web store http://shop.equalexchange.com Coupon code: dwdg10 Coupon expires December 31, 2015 Source: EE Corporate Office - Marketing. CHE-HITT11E-13-0403-CaseStudy11.indd 126 22/10/13 2:47 PM Case 11: Equal Exchange: Doing Well by Doing Good It includes a dozen formal partners: American Friends Service Committee, American Jewish World Service, Catholic Relief Services, Baptist Peace Fellowship of North America, Church of the Brethren, Disciples of Christ, Lutheran World Relief, Mennonite Central Committee U.S., Presbyterian Church USA, United Church of Christ, United Methodist Committee on Relief, and Unitarian Universalist Service Committee. The fair trade products distributed through these interfaith partnerships provide faith-based organizations with another opportunity to live in accord with their values and to discuss their connections and fellowship with those who grow and harvest food around the world. EE also provides materials to educate consumers on issues of economic justice, sustainable farming, and the effects of an increasingly industrialized food industry dominated by a small number of firms. The development of the interfaith channel is a great example of entrepreneurship in action among the workerowners at EE. Prior to the mid-90s, EE worked with congregations on an ad hoc, one-by-one basis. It was Timothy Bernard, a Lutheran minister, and Erbin Crowell, an EE salesperson that hit upon the idea of establishing formal relationships with faith-based communities. In North's words: \"Erbin had to sell this idea internally to Dickinson and others and Timothy had to do likewise within the Lutheran community's leadership. Eventually, they created a pilot project which grew to be very successful.\" Another example of entrepreneurship within EE was led by Virginia Berman. She began with fundraising opportunities with elementary, middle, and high schools; instead of selling items such as magazine subscriptions and popcorn, the schools would sell fair trade products from EE. Berman began to hear that the teachers wanted to help their students grasp the significance of fair trade. In response, Berman requested and received funding to create educational materials. Today, there is a flexible and engaging free-to-download curriculum targeted for late elementary through middle school age children on the EE Web site. To reach the technologically savvy, EE has embraced social media such as Twitter, YouTube, and Facebook to communicate its message to current and potential consumers. Additionally, EE takes advantage of electronic media to provide e-newsletters and offers an unusually active, in-depth, and outspoken blog. All of these efforts are, as Miller said, \"To try to connect with the public and consumers.\" The use of social media also reinforces its marketing efforts through retail stores and the interfaith network. Moreover, it leads to its fourth marketing channel, the Internet. In 2011, Internet sales to individual shoppers accounted for approximately two percent of CHE-HITT11E-13-0403-CaseStudy11.indd 127 127 sales. EE expects Internet sales to hit one million in 2012. Currently, EE is looking at how to expand its Internet sales. With over half of the interfaith sales previously discussed executed via online stores, approximately 12 percent of EE's sales come through the Internet. EE's two cafs are its fifth form of marketing and distribution. EE started selling its products through cafs prior to the 2008 recession; one in Boston and the other in Seattle. Due to high capital costs and the challenge of winning new customers, it takes even popular cafs between 18 and 24 months to break even. For now, EE has placed the further addition of cafs on hold. Instead, it is trying a different way to reach out and touch customers. In keeping with the EE tradition of thinking outside the box, it has developed cafs on wheels. They are described by Albert as follows: We have two custom built tricycles very close to completion. They'll be in the Boston market probably within the next 30 to 60 days. They are stand alone. They have marine batteries and they carry all the supplies they need. They can brew coffee right there onsite. If you park it here in the morning and not much action, you can park it over there in the afternoon, yeah, that seems to be a better spot. It's kind of a brand building, and they have kind of a wow factor.6 EE is not alone in this endeavor; some independent cafs have also adopted a mobile approach to reach customers. For example, Common Grounds: A Fair Trade Coffee House in Salisbury, MD uses a converted trailer to reach customers at community events such as the West Wicomico Heritage Bike Tour and Salisbury University's Freshman Move-In Day. As with all fair trade products, which tend to occupy the premium or gourmet segment of their categories, the pricing is above that charged by mass-marketers such as Maxwell and Kraft. This reflects the higher quality and the higher unit costs of a small firm, but it also supports the higher prices paid to the producers. Yet, the prices for EE products are still on par with much larger competitors such as Starbucks, Peet's, and Green Mountain, who offer comparable quality coffee. To persuade customers to buy its product without the aid of expensive marketing campaigns, EE uses a significant amount of informational marketing. For example, as stated earlier, on the packaging of every chocolate bar, tea bag or box, and every bag of coffee is the slogan, \"Small Farmers, Big Change.\" In addition, information on how the product is grown, who grows it, where it was grown, and why it is different often appears on the packaging material. Sometimes pictures of growers also appear. To further differentiate the products, fair trade and USDA Organic 22/10/13 2:47 PM 128 Part 4: Cases seals are on the packaging materials, as well. EE tries to use every opportunity to get its message across and connect with the public and consumers. Finance7 EE issues two forms of stock - Class A Common Stock and Class B Preferred Stock. Every worker-owner must own one share of Class A stock, and no more. No one else may purchase it. This ensures equal voting rights, one person-one vote, and to a larger degree, equal power among all worker-owners. Worker-owners purchase a share when they are elected into the company after completing their probationary first year. When originally issued in 1990, each share was worth $2000. In January 2011, each Class A share was worth $3,170. To prevent the cost of stock ownership from being an obstacle to joining the cooperative, new worker-owners, once elected, are provided with an interest free loan to purchase their share. They have four years to repay the loan and can repay with the cash portion of the patronage distribution. Both worker-owners and outsiders can own Class B Preferred Stock. Shares sell for $27.50. The board declares dividends annually usually in January; commonly, dividends are targeted at five percent. Originally, individual shares could be purchased. As Everts related, \"Someone could buy a share for their grandchild for $27. We loved that type of thing, but we are operating under limits of 500 maximum outside shareholders. If you exceed that limit, then it is considered to be publicly traded.\" In 2011, preferred shares were sold only in lots equal to or greater than $10,000.8 Exhibit 7 Statements of Operations and Retained Earnings Years Ended December 31 2006 2007 2008 2009 2010 2011 SALES $23,639,000 $29,370,480 $34,440,241 $35,832,510 $36,525,856 $46,819,829 COST OF SALES $14,165,000 $18,866,940 $22,446,593 $23,075,260 $26,659,316 $33,617,786 GROSS PROFIT $9,474,000 $10,503,540 $11,993,648 $12,757,250 $12,866,540 $13,202,043 OPERATING EXPENSES $7,946,000 $8,646,241 $9,535,120 $10,771,023 $11,234,758 $11,350,116 INCOME FROM OPERATIONS $1,528,000 $1,857,299 $2,458,528 $1,986,227 $1,631,782 $1,851,927 $(576,000) $(737,131) $(720,437) $(622,848) $(323,662) $(387,182) $3,754 $14,832 $7,346 OTHER (EXPENSE) INCOME: Interest Expense \u0007Reduction of Investment to Market Value $(80,000) Bad Debt Expense Loans $(38,759) $(80,000) Charitable Contributions Expense $(5,296) $(105,000) Interest Income $22,118 $9,314 \u0007Bad Debt (expense) Recovery, Net Trade INCOME BEFORE INCOME TAXES $(14,265) $952,000 $(759,068) $(990,388) $1,098,231 $1,468,140 $1,367,133 $1,322,952 $1,472,091 $325,000 $435,000 $430,000 $484,000 $689,000 $110,000 $165,000 $163,000 $94,000 $(40,000) $435,000 $600,000 $593,000 $578,000 $649,000 PROVISIONS FOR INCOME TAXES: Current Deferred $415,000 NET INCOME RETAINED EARNINGS, Beginning of Year Less: Preferred Stock Dividends Paid RETAINED EARNINGS, End of Year $537,000 $663,231 $868,140 $774,133 $744,952 $821,042 $1,255,725 $1,619,725 $2,069,068 $2,654,249 $3,174,783 $3,595,014 $(173,000) $(213,888) $(282,959) $(253,599) $(324,721) $428,917 $1,619,725 $2,069,068 $2,654,249 $3,174,783 $3,595,014 $3,987,139 Source: These 6-year consolidated financial statements were constructed from financial data published by EE on the Web at http://www.equalexchange.coop/investing. CHE-HITT11E-13-0403-CaseStudy11.indd 128 22/10/13 2:47 PM 129 Case 11: Equal Exchange: Doing Well by Doing Good Exhibit 8 Balance Sheet December 31 2006 2007 2008 2009 2010 2011 ASSETS CURRENT ASSETS: Cash and Equivalents $480,150 $381,497 $212,717 $376,667 $823,699 $757,429 $1,569,117 $1,973,098 $2,227,843 $2,185,768 $2,655,707 $2,849,063 $10,500 $34,174 $88,628 $324,996 $17,538 $34,800 $6,983,311 $8,193,630 $10,839,429 $8,293,729 $8,290,646 $15,117,041 $381,538 $766,611 $928,227 $415,139 $535,330 $800,338 $75,000 $77,000 $145,000 $115,000 $377,496 $367,496 TOTAL CURRENT ASSETS $9,499,616 $11,426,010 14,441,844 $11,711,299 $12,700,386 $19,926,167 PROPERTY AND EQUIPMENT, NET $6,497,284 $7,311,901 $7,473,243 $7,017,564 $6,653,683 $5,979,771 $64,154 $49,194 $35,434 $28,994 $211,153 $182,212 Investments $100,000 $151,326 $190,870 $381,861 $68,513 $43,360 Notes Receivable, Net of Current Portion $128,233 $281,188 $234,473 $6,039 $38,501 $39,249 $16,289,287 $19,220,219 $22,375,864 $19,145,457 $19,672,236 $26,170,759 $3,006,846 $4,022,153 $5,164,438 $624,928 $567,952 $3,463,192 \u0007Capitalized Lease Obligations, Current Portion $250,328 $420,470 $447,679 $432,124 \u0007Mortgages and Other Notes Payable, Current Portion $200,001 $319,677 $1,639,829 $550,639 $121,793 $1,253,534 $1,219,767 $1,079,240 $940,158 $1,089,703 $1,539,374 $2,198,802 $661,840 $660,063 $769,526 \u0007Accounts Receivable - Trade, Net of Reserve for Possible \u0007Uncollectible Accounts of $50,000 in 2009 and 2008 Notes Receivable Other Inventories \u0007Prepaid Expenses, Advances in Inventory, and Other Current Assets Deferred Income Tax Asset OTHER ASSETS: Intangible Assets, Net TOTAL ASSETS LIABILITIES AND STOCKHOLDER EQUITY CURRENT LIABILITIES: Notes Payable - Lines-of-Credit Accounts Payable and Accrued Expenses \u0007Accrued Expenses and Other Current Liabilities Corporate Income Taxes Payable Patronage Rebates Payable TOTAL CURRENT LIABILITIES $271,632 $228,036 $418,205 $255,255 $421,875 $147,000 $376,382 $5,566,818 $6,919,808 $9,216,885 $3,119,269 $2,376,119 $7,563,542 $886,058 $1,572,897 $1,125,216 $693,092 $- $3,238,671 $3,259,969 $2,875,097 $3,190,008 $3,228,784 $2,616,521 $292,000 $404,000 $637,000 $770,000 $900,000 $850,000 $9,963,547 $12,156,674 $13,854,198 $7,772,369 $4,128,784 $3,466,521 LONG-TERM LIABILITIES \u0007Capitalized Lease Obligation, Non-Current Portion \u0007Mortages and Other Notes Payable, Non-Current Portion Deferred Income Taxes COMMITMENTS AND CONTINGENCIES TOTAL LIABILITIES (Continued) CHE-HITT11E-13-0403-CaseStudy11.indd 129 22/10/13 2:47 PM 130 Part 4: Cases Exhibit 8 (Continued) Balance Sheet December 31 2006 2007 2008 2009 2010 2011 STOCKHOLDERS' EQUITY: \u0007Preferred Stock; Authorized 299,800 Shares; Issued and Outstanding 390,116 Shares in 2011, 333,262 Shares in 2010, 290,429 Shares in 2009 and 206,864 Shares in 2008 $4,564,605 $4,829,986 $5,680,390 $7,978,429 $9,156,382 $10,728,960 \u0007Common Stock: Authorized 200 Shares; Issued and Outstanding, 108 Shares in 2011, 107 Shares in 2010, 99 Shares in 2009, 93 Shares in 2008, 85 Shares in 2007, 81 Shares in 2006 $222,165 $232,555 $260,903 $282,683 $313,343 $318,753 \u0007Less: Common Stock Subscriptions Receivable $(80,755) $(68,064) $(73,876) $(62,807) $(60,682) $(59,480) $1,619,725 $2,069,068 $2,654,249 $3,174,783 $3,595,014 $3,987,139 Retained Earnings TOTAL STOCKHOLDERS' EQUITY TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,325,740 $7,063,545 $8,521,666 $11,373,088 $13,004,057 $14,975,372 $16,289,287 $19,220,219 $22,375,864 $19,145,457 $19,355,278 $26,170,759 Source: These 6-year consolidated financial statements were constructed from financial data published by EE on the Web at http://www.equalexchange.coop/investing. When EE offers its preferred shares, it does so in the following manner according to Everts: We do have to be diligent and deliberate about talking to people and sharing. We have a very extensive disclosure document that everyone has to look at before they invest in us. There's got to be some connection to EE to get them here in the first place, whether it's a personal connection or whether they represent an account of ours; maybe they actually are a worker-owner and they want to be an investor, too. It has to be people who fundamentally know us and have direct access to the books and can see quite closely. To assure direct access to financial information, EE practices an extreme form of open-book management. Privately or closely held firms such as EE are not required to make available to the public an annual report, but the company publishes each year's annual report on its Web site. The financial statements for 20062011 were extracted from those reports and are contained in Exhibits 7 and 8. EE goes further by putting all of its annual reports dating back to 1986 online and includes a Spanish language version for its suppliers in Latin America that represent 90 percent of EE's imports.9 Preferred shares are sold as a long-term investment. Preferred stockholders can redeem shares for their full price only after five years. Shares cannot be redeemed until after two years and then for only 70 percent of their value, 80 percent after three, and 90 percent after four. CHE-HITT11E-13-0403-CaseStudy11.indd 130 There is a provision in the disclosure statement that the board of directors \"... may postpone or delay a request for redemption\" if the total debt to total equity ratio exceeds 2:1 or the redemption would cause it to exceed that ratio. In addition, Class A Common Stock and Class B Preferred Stock have the following unusual restriction and explanation for that restriction on them in the disclosure document: On the sale of all the assets, liquidation or dissolution of the corporation, any residual assets left after the payment of all debts shall be distributed first to the Class B shareholders in the amount equal to the balances in their internal accounts and then to the current members or, if said residual assets are insufficient, then on a pro rata basis in proportion to the relative balances in their internal accounts. Any assets remaining after said distribution shall be distributed to an alternative trading organization as so determined by the board of directors of the corporation. Basically, if any capital gain as a result of the company's growth is ever realized through a sale, it stays within the fair trade community rather than being distributed to stockholders. According to North: The mission purpose of this treatment is to remove the temptation that the Company would ever be sold for personal financial gain, and reflects that EE was created to 22/10/13 2:47 PM 131 Case 11: Equal Exchange: Doing Well by Doing Good do something quite specific, to carry out fair trade and to model a new approach to business, and not as vehicle to generate wealth for any one stakeholder. Therefore, the likelihood is that the company will remain independent, despite a steady stream of buy-out offers, and its mission remains intact. As the mission and the dividends, not the capital gain, are the basis for investment, this protects the stockholder's interest. This version of a \"poison pill\" to prevent takeover by outsiders is uncommon. Some at EE call it the \"No Exit Strategy.\" Albert related the following regarding this provision: Anecdotally, I bumped into an attorney, she specializes in ESOP's and employee owned accounts ... she said that our by-laws are maybe a little over the top, but in the next breath said she's used them more than once as the model for others. To raise additional working capital, EE uses an unusual method for debt financing. Anyone can buy an EE Certificate of Deposit (CD) through Eastern Bank of Massachusetts. The minimum for these CDs is $500. By 2012, EE had raised over $1 million via CDs. It also has received loans from the Calvert Foundation, Everance, religious institutions, and individual supporters. EE refers to these organizations and individuals as mission lenders. How the sources of capital have changed between 2005 and 2010 is shown in Exhibit 9. Although atypical, EE's financial policies collectively support its unusual governance model for a for-profit corporation. The Industry The industry consists of large multinationals that sell coffee, chocolate (i.e., Hershey, Nestle, and M&M/ Mars), tea (i.e., Lipton), bananas (Dole and Chiquita) and other competitive products and small competitors. Everts says that EE is a victim of its own success. Since 1986, a number of fair trade firms have sprung up. Everts estimates that 700 or 800 other coffee roasters - large and small - are doing some amount of fair trade. For example, Starbucks now sells more fair trade coffee than EE, but it represents only a small percentage of Starbuck's total sales. The same is true of Dunkin' Donuts. In contrast, the U.S. companies deeply engaged in fair trade tend to be small. According to a 2009 study by the Fair Trade Federation (FTF), the average number of full-time employees in a fair trade company is fewer than 10. In addition to other companies getting into fair trade, there are organizations competing to certify what is a fair trade product. Starting in 2012, Fair Trade USA (aka Transfair) will certify coffee, cocoa, and sugar grown on large-scale plantations and private estates as fair trade. Other terms such as \"shade grown\" applied in the industry to products sold by EE and others do not have a common definition. Fair trade is growing rapidly. According to a 2012 report published by Fair Trade International, global sales Exhibit 9 Sources of Capital 2005 and 2010 Workers $12,000,000 Profit Investors Debt \"Class B\" \"Class A\" $10,000,000 2005 $8,000,000 2010 $2,000,000 $4,000,000 $2,000,000 $0 Class A Profit Class B Debt Source: This graph was constructed from financial data published by EE on the Web at http://www.equalexchange.coop/investing. CHE-HITT11E-13-0403-CaseStudy11.indd 131 22/10/13 2:47 PM 132 Part 4: Cases of fair trade certified goods were $6.6 billion in 2011, a 12 percent increase from 2010, and 44 percent over 2009 sales.10 FTF estimated in 2008 the total market for fair trade products bought in the United States was $1.18 billion. North estimates that at retail, U.S. fair trade in 2011 was over $2 billion. In the same FTF report, increases in sales by product varied even for the same country. For example, fair trade coffee, the largest fair trade product, grew approximately 32 percent between 2010 and 2011 in the United States. In contrast, tea grew by 21 percent and cocoa grew by 67 percent in the same time period in the United States. Obviously, fair trade is growing more rapidly than non-fair-traded products. This growth is occurring in part because natural and fair trade products have gone mainstream. In 2006 the Hartman Group reported, \"Almost threequarters (73 percent) of the U.S. population consume organic foods or beverages at least occasionally. Clearly, the conventional belief that all organic users are highly educated, high-income, Caucasian females should be put to rest.\" \"LOHAS\" is an industry term standing for Lifestyles of Health and Sustainability and may better serve as a moniker for those consumers who frequent outlets such as Whole Foods and food co-ops. According to North, reported that they had recently purchased a fair trade item. This pattern may be changing. Researchers from the Massachusetts Institute of Technology, Harvard University, and the London School of Economics found \"substantial consumer support for fair trade, although a segment of price-sensitive shoppers will not pay a large premium for the fair trade label.\"11 The consumers who were already purchasing premium coffee were willing to pay an additional 8 percent for fair trade labeled premium coffee. The FTF expects the market to continue to grow if distribution widens and consumers can more easily identify fair trade products. Challenges Although EE is the largest company in the United States selling fair trade products exclusively and has continued to grow, Everts sees challenges ahead. One is the trend toward locally grown or prepared food. Obviously, coffee cannot be grown locally in the continental United States; but, it is increasingly locally roasted, a very popular selling point. The significant challenge that Everts sees is \"How does EE remain entrepreneurial?\" As he said: They are interested enough in being healthier and supporting environmental sustainability that they spend more time researching their purchases, they'll go out of their way, and they'll pay more (but not just any price). Some of them are also interested in matters of fairness and social justice - and will shape their purchases accordingly. One challenge ahead is being prepared to take more risks, being prepared to reinvest in ourselves structurally, or whether it's to spin off cooperatives. We're contemplating this with the retail caf sector. Being prepared to take risks and also how do we look at this thing, a big company succeeding in many local markets where we aren't necessarily based there, that's a challenge. In a 2008 study by Alter Eco USA, 71.4 percent of U.S. consumers reported that they had heard the term \"fair trade.\" However, less than 10 percent surveyed Given EE's leadership, worker-owners, culture, and history, changes do seem inevitable. The question is \"What changes will they make?\" Notes 1. 2. The research on this company was partially supported by the Foundation for Enterprise Development. This case is copyrighted by the authors. Please address all questions to Frank Shipper at fmshipper@salisbury. edu, (410) 543-6333. The authors would like to thank the worker-owners of Equal Exchange who graciously shared their knowledge, experiences, and perspectives about the company. Their viewpoints were invaluable in ensuring that this case provides a true representation of the culture and practices of the company. Sales figures for 2010, 2011, and 2012 were adjusted for the 2010 acquisition of Oke USA, an importer and seller of organic bananas. The Statement of Operations CHE-HITT11E-13-0403-CaseStudy11.indd 132 3. 4. 5. 6. and Retained Earnings in Exhibit 7 is unadjusted. Source: http://www.equalexchange.coop/ worker-owned/. Accessed July 25, 2012. Source: Internal document entitled, \"Evolution of EE Governance: WorkerOwner Oversight of Education Committee.\" \"Cup coffee\" is an expression used to describe the industry standard process to test the quality of coffee. The trikes were introduced after this interview was conducted. To see a Boston Globe article about them go to http:// www.boston.com/ae/food/restaurants/ articles/2010/09/22/thanks_to_equal_ exchange_trikes_its_one_whole_cafe_with_ cream_and_sugar_to_go/. 7. 8. 9. 10. 11. Financial Statements can be found in Exhibits 7 and 8. The JOBS Act of 2012 raised the limit from 500 to 2,000 investors before a company is to be publicly traded. This change is expected to be helpful to EE as well as other ESOP companies over the next 10 years. Source http://www.equalexchange.coop/ annual-reports/index.php. Accessed July 25, 2012. Source: See: http://www.fairtrade.net/ single_view1+M528a593be0f.html. Accessed July 26, 2012. Hainmueller, J., Hiscox M., & Sequeira S. 2009. Consumer Demand for the Fair Trade Label: Evidence from a Field Experiment, Working Paper. 22/10/13 2:47 PM 1. Explain how the forces in the general environment impact the firm's operations? 2. Describe the structure of the industry? 3. Identify and describe the firm's major competitors and the basis of their competitiveness? 4. Apply Porter's five forces model 5. Conduct swot analysis; Analyze the external and internal environments: Identify opportunities and threats Identify strengths and weaknesses