L.L. Bean Item Forecasting Case Study Sample Assignment

When you order an item from an L.L. Bean catalog and we’re out of stock, I’m the guy to blame. And if we end up liquidating a bunch of women’s wool cashmere blazers, it’s my fault. No one understands how tough it is.” Mark Fasold, Vice President—Inventory Management, was describing the challenge of item forecasting at L.L. Bean. “Forecasting demand at the aggregate level is a piece of cake—if we’re running short of expectations, we just dip deeper into our customer list and send out some more catalogs. But we have to decide how many chamois shirts and how many chino trousers to buy, and if we’re too high on one and too low on the other, it’s no solace to know that we were exactly right on the average. Top management understands this in principle, but they are understandably disturbed that errors at the item level are so large. “In a catalog business like ours, you really capture demand. That’s the good news. The bad news is, you learn what a lousy job you’re doing trying to match demand with supply. It’s not like that in a department store, say, where a customer may come in looking for a dress shirt and lets the display of available shirts generate the demand for a particular item.

Or if a customer has some particular item in mind but it’s not available, he or she may just walk out of the store. In a department store you never know the real demand or the consequences of understocking. But in our business every sale is generated by a customer demanding a particular item, either by mail or by phone. If we haven’t got it, and the customer cancels the order, we know it.” Rol Fessenden, Manager—Inventory Systems, added: “We know that forecast errors are inevitable. Competition, the economy, weather are all factors. But demand at the item level is also affected by customer behavior, which is very hard to predict, or even to explain in retrospect. Every so often some item takes off and becomes a runaway, far exceeding our demand forecasts. Once in a while we can detect the trend early on and, with a cooperative vendor, get more product manufactured in a hurry and chase demand; most of the time, however, the runaways leave us just turning customers away. And for every runaway, there’s a dog item that sells way below expectations and that you couldn’t even give away to customers.” Annual costs of lost sales and backorders were conservatively estimated to be $11 million; costs associated with having too much of the wrong inventory were an additional $10 million.

This case was prepared by Professor Arthur Schleifer, Jr. as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1992 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

L.L. Bean, Inc.

L.L. Bean Background

In 1912 Leon Leonwood Bean invented the Maine Hunting Shoe (a combination of lightweight leather uppers and rubber bottoms). He obtained a list of nonresident Maine hunting license holders, prepared a descriptive mail-order circular, set up shop in his brother’s basement in Freeport, Maine, and started a nationwide mail-order business. The inauguration of the U.S. Post Office’s domestic parcel post service in that year provided a means of delivering orders to customers. When L.L. Bean died in 1967, at the age of 94, sales had reached $4.75 million, his company employed 200 people, and an annual catalog was distributed to a mailing list of 600,000 people. L.L.’s Golden Rule had been “Sell good merchandise at a reasonable profit, treat your customers like human beings, and they’ll always come back for more.” When Leon Gorman, L.L.’s grandson, succeeded him as president in 1967, he sought to expand and modernize the business without deviating from his grandfather’s Golden Rule. By 1991, L.L. Bean, Inc. was a major cataloger, manufacturer, and retailer in the outdoor sporting specialty field: Catalog sales in 1990 were $528 million, with an additional $71 million in sales from the company’s 50,000 square-foot retail store in Freeport. Twenty-two different catalogs (often referred to as “books” by company employees)—114 million pieces in all—were mailed that year.

There were six million active customers. The mail-order business had been giving way to telephone orders after the company installed nationwide “800” service in 1986. By 1991, 80% of all orders came in by telephone. Major direct-mail competitors included Land’s End, Eddie Bauer, Talbot’s, and Orvis. A 1991 Consumer Reports survey on customer satisfaction with “mail-order” companies found L.L. Bean heading the list for overall satisfaction in every category for which they offered merchandise. In explaining why L.L. Bean had not expanded its retail operations beyond the one store in Freeport, Leon Gorman contrasted the direct-marketing (catalog) and retail businesses. “The two approaches require very different kinds of management. Mail-order marketers are very analytic, quantitatively oriented. Retailers have to be creative, promotional, pizzazzy, merchandise-oriented. It’s tough to assemble one management team that can handle both functions.”

Product Lines

L.L. Bean’s product line was classified hierarchically (see Exhibit 1). At the highest level of aggregation were Merchandise Groups: men’s and women’s accessories, men’s and women’s apparel, men’s and women’s footwear, camping equipment, etc. Within each Group were Demand Centers; for instance, women’s apparel had as Demand Centers knit shirts, sweaters, pants, skirts, jackets and pullovers, etc. Each Demand Center was further broken down into Item Sequences; for example, women’s sweaters consisted of Midnight Mesa Handknit Cardigans, Indian Point Pullovers, Lambswool Turtlenecks, and about twenty other products. Item Sequences were further broken down into individual items, distinguished primarily by color; it was at this item level that forecasts had to be issued and, ultimately, purchase commitments had to be made.2 About 6,000 items appeared in one or another of the catalogs that were issued in the course of a year.

1L.L. Bean, Inc.: Corporate Strategy, Harvard Business School Case (581-159), 1981. 2Items were further broken down by size into stock-keeping units, or SKUs.

This was done by applying standard size-distribution breakdowns. Although an inappropriate distribution could lead to excessive inventory of some sizes and stockouts of others, management concern was directed to the item level, since there was no evidence of a better system than assuming that the distribution of demand by size would behave in the future as it had in the past, and would be indistinguishable from one item to another.

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Items were also classified into three seasonal categories (spring, fall, and all year), and into two additional categories (“new” or “never out”) that described whether the item was a recent or more permanent member of the company’s offerings, and consequently characterized the amount of historical demand data available for the item.

The Bean Catalogs

The major catalogs—spring, summer, fall, and Christmas—each came out in several versions. A “full” catalog, running from 116 to 152 pages, went to Bean’s regular customers. A smaller “prospect” catalog was circulated to potential customers; it contained primarily a subset of items from the full catalog. (Bean identified such prospect customers in a variety of ways, for example, through the purchase of mailing lists, or by recording recipients of gifts from other Bean customers.) In addition, a number of specialty catalogs—Spring Weekend, Summer Camp, Fly Fishing, etc.— presented items that were unique to that catalog, as well as some items found in the major catalogs. There was some overlap in circulation: the best customers received almost all the catalogs, and those customers known, through past purchasing behavior, to be interested in various specialties might receive an appropriate specialty catalog in addition to the seasonal full catalogs.

Item Forecasting

Each catalog had a gestation period of about nine months, and its creation involved merchandising, design, product, and inventory specialists. For example, the initial conceptualization for the Fall, 1991 season began in October, 1990. Preliminary forecasts of total sales for each catalog were made in December. Product managers developed preliminary item forecasts by book in the December, 1990 to March, 1991 time frame. Layout and pagination of the books began in January, 1991. Initial commitments to vendors were made in January and February. In the subsequent months, as the catalogs took shape, item forecasts were repeatedly revised and finally “frozen” by May 1. By early July a black-and-white version of the layout was available internally. At this point, the product managers handed off their product line to the inventory managers. The completed Fall 1991 catalogs were in the hands of customers around August 1. As the catalog generated demand, inventory managers decided on additional commitments to vendors, scheduled replenishments, handled backorders, etc. This catalog remained active through January, 1992; inventory left over at that time might be liquidated, marked down and sold through special L.L. Bean promotions, or carried over to the next year.

Scott Sklar was a buyer for men’s shirts. He described the forecasting process as follows: “Four or five of us—my inventory buyer, some product people, and I—meet to forecast shirt sales by book. We start by ranking various items in terms of expected dollar sales. Then we actually assign dollars in accordance with the ranking. There’s discussion, arguments, complaints. People invent rules of thumb. I say ‘invent,’ because there aren’t any good rules of thumb. “We set this up on an Excel spreadsheet. We look at the book forecast and make adjustments accordingly. We look at the total of forecasted shirt sales and check it for reality. Does it feel good? Does it make sense? We do it book by book, item by item, and that’s how we get an item level forecast.

“Of course, when we add a new item, we have to make a judgment: will this item generate incremental demand, and if not, from what items is it going to steal demand? And then those items need to be adjusted accordingly.”

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Barbara Hamaluk, a buyer for men’s knit shirts, observed that the sum of the item forecasts for a catalog was often at variance with the dollar target for that book. “Usually this roll-up comes in on the high side, so you try to reduce forecasts on certain items. Or you can just say, if we’re too high by 10%, we’ll just slash everything across the board by 10%. We really ought to have an intermediate level of forecasts at the Demand Center level, reconcile item forecasts with Demand Center forecasts, and the latter with the book forecast.”

Production Commitments

The typical production lead time for most domestic orders was eight to twelve weeks. (Of course, deliveries against a commitment could be scheduled to conform to the anticipated pattern of in-season demand.) With some vendors who cooperated with L.L. Bean’s “Quick Response” initiative, it was possible, after observing some early-season demand, to place a second order, which would be delivered in sufficient time to meet late-season demand. However, with many domestic and most offshore vendors, lead times were sufficiently long so that it was impractical to place a second commitment order in the course of the season. (In the remainder of this case, then, discussion will be limited to these “one-shot” commitments.)

The commitments were generally not equal in size to the forecasts, but were determined in two steps as follows: First, historical forecast errors (expressed as “A/F ratios” the ratio of actual demand to forecast demand) were computed for each item in the previous year, and the frequency distribution of these errors was compiled across items.3 The frequency distribution of past forecast errors was then used as a probability distribution for the as yet unrealized future forecast errors. For example, if 50% of the forecast errors for “new” items in the past year had been between 0.7 and 1.6, then it would be assumed that with probability 0.5, the forecast error for any “new” item in the current year also would fall between 0.7 and 1.6. So in such a case, if the frozen forecast for a particular item were 1,000 units, it was then assumed that with probability 0.5, actual demand for that item would end up being between 700 and 1,600 units.

Next, each item’s commitment quantity was determined by balancing the individual item’s contribution margin if demanded against its liquidation cost (or value) if not demanded. Suppose, for example, that an item cost Bean $15, would regularly sell for $30, and could be sold at liquidation for $10. The gain for selling a marginal unit would be $30 – 15 = $15; the loss for failing to sell the marginal unit would be the cost less the liquidation value, i.e. $15 – 10 = $5. Accordingly, the optimal order size should be the 0.75 fractile of the item’s probability distribution of demand. Suppose the 0.75 fractile of the distribution of forecast errors was 1.3, and the frozen forecast for that item was for 1,000 units. Then the 0.75 fractile of the demand distribution would be 1,000 x 1.3 = 1,300, and Bean would make a commitment for 1,300 units.

Rol Fessenden expressed concern that the methodology treated the errors associated with all “never out” items as equally representative of the forecast errors that might be anticipated for the forecast demand of any “never out” item (and similarly for “new” items). “You’d think that the error distribution for some of our buyers might be tighter than for other buyers, or that the distribution for women’s sweaters might have more dispersion than the distribution for men’s footwear, but we can’t find any real differences. Also, I’m not entirely convinced that we go about estimating contribution margin and liquidation cost correctly.”

Mark Fasold was worried about the wide dispersion in forecast errors, both for “never outs” and “new” items. He was also concerned about the implications of the methodology: “If the cost

3This was done separately for “new” items and for “never outs”; not surprisingly, the historical error distribution of “never outs” had less dispersion than that of “new” items. No other way of segmenting ite s had revealed significantly different distributions of forecast errors.

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associated with understocking exceeds the cost of overstocking, which is the usual case here, we end up committing to more than the frozen forecast. And for “new” items, about which we obviously know very little, the excess over the frozen forecast is even greater than for “never outs.” The buyers are understandably upset when we commit to more than they forecast; they perceive us as going way out on a limb for “new” items.”

Questions And Answers On Planning

Why is scheduling fairly simple for repetitive systems but fairly complex for job shops? Scheduling for repetitive systems is fairly simple because the activities and equipment used is the same. This goes for high-volume and medium volume systems because the productions are the similar. Scheduling for job shops is more difficult because the products formed are customized or of a personal nature and therefore are not mass produced. Stevenson,

What problems not generally found in manufacturing systems do service systems present in terms of scheduling the use of resources? Customer requirements in service systems generally present very different circumstances than those encountered in manufacturing systems. Some services can use appointments and reservations for scheduling purposes, although not all systems are amenable to this. When multiple resources are involved, the task of balancing the system can be fairly complex.

Explain forward and backward schedulings and each one’s advantage.

  • Forward scheduling : Scheduling ahead from a point in time. Forward scheduling is used if the issue is “How long will it take to complete this job?” Forward scheduling enables the scheduler to determine the earliest possible completion time for each job and, thus, the amount of lateness or the amount of slack can be determined.
  • Backward scheduling: Scheduling backward from a due date. Backward scheduling would be used if the issue is “When is the latest the job can be started and still be completed by the due date?” With backward scheduling the scheduler is able to determine if the due date can be met.

Luna Pen Case Study

A Puzzling Request

Erika Graeper absently twirled the Luna in her fingers. It was not as massive as the Mont Blanc’s Meisterstück or the most expensive Pelikans, but the Luna had a comfortable heft and balance. It was handsome, as well. The pen’s midnight blue barrel was accented by a gold clip, and an elegant crescent moon was inlaid at the top of the cap.

Erika smiled to herself, as the Luna tripped memories of both pleasure and small embarrassment. It had been given to her by her grandmother a dozen years ago when she had been about to start university. Erika had promptly used the pen to write a thank you note on crisp white stationery and had solemnly said that it would be a great help in her studies. Once at school, however, she had reverted to ball point pens and mechanical pencils. Since then, the Luna had been tucked, unused, in the back of a desk drawer.

The gift certainly would still have been forgotten had not an odd letter happened to come to her desk at DGG the first month she started to work for that company. Judging by the notes that had been scribbled on it, the letter had gone past three other people before being forwarded to her. Her immediate boss, Wilhelm Mann, had scribbled a cryptic instruction that said in its entirety: “Please respond—Luna out of production for years.”

Mann was out of the office and was unavailable to provide more information, so Erika had turned to the letter itself. It was from Cecil Armstrong, president of Queensland Office Supply, Ltd., in Brisbane, Australia, and was addressed to Herr Heinrich Dumart, president of Luna, in Frankfurt, Germany. Armstrong’s letter complained of difficulties in obtaining Luna pens for the retailers with whom he dealt. “Small wonder,” Erika thought to herself, “since Lunas aren’t made any more.” But as she read further, she became perplexed. Armstrong had written: “Your representative, Mr. Alven Feng, assures me that manufacturing is being stepped up to meet increased demand, but his deliveries often are late and are insufficient to satisfy my customers’ needs.” Erika checked back to see the date of the letter—January 12, 2002. It had probably taken less than a week to arrive from Australia, but another three months had passed as the letter had bounced from one office at DGG to another until it found its way to Erika. Nevertheless, Armstrong was writing as if the Luna were still being made. It seemed unlikely, but perhaps her boss had been wrong about the pen being out of production.

Professors Kathleen McGinn and Michael Wheeler prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 1995 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

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Luna Pen (A)

Armstrong’s letter went on to praise the pen and to encourage the Luna company to take full advantage of its growing market. “I do not know the nature of your relationship with Mr. Feng, but if he does not have exclusive rights to represent you in this part of the world, I would very much like to pursue that possibility for Australia.”

Armstrong had attached a copy of a letter he had written a year earlier, likewise asking about distribution rights. Attached, as well, was a letter dated November 5, 2001, from Alven Feng to Cecil Armstrong. He promised new pens would be delivered shortly, but stated that while Luna was striving to meet increased demand, it did not want to compromise quality to do so. Feng’s letterhead identified him as “Managing Director” of Global Service Company, Taipei, Republic of China. Erika recalled that meant Taiwan, not mainland China, but never had heard of Feng’s company. “Please respond,” Erika’s boss had directed her. But how was she to reply to a request from someone halfway around the world regarding a product that was no longer made?

Erika Graeper

Erika’s only knowledge of the Luna pen came from the fact that her grandmother happened to have given her one long ago. Erika had been trained in electrical engineering, had worked for a German audio speaker manufacturer for three years, then earned her MBA from the University of Texas, Austin, in 1999. Her decision to attend professional school in the United States surprised her friends and family, but Erika had wanted to see more of the world. She chose Texas specifically because of the university’s ambitious partnership with private corporations to spawn new computer technology.

As she had hoped, business school expanded her interests beyond engineering; somewhat to her surprise, she became particularly fascinated with marketing. Upon graduation, Erika went to work for Dell Computer right in Austin, Texas. Dell had grown enormously in just a few years, by assembling quality products and selling many of them through technical product centers on university campuses throughout the United States.

Erika enjoyed her two years at Dell, but with the changes at the company she felt the job was not giving her the kind of experience she had hoped for. While on a brief vacation to her family’s home outside of Frankfurt, she happened to hear of an interesting position that had opened up at DGG, a fast-growing distributor of computer peripherals and related supplies. DGG had started as a small greeting card company, the Deutsche Grusskarte Gesellschaft, but through a series of acquisitions and mergers, it moved into stationery and, then, office products. When it expanded beyond Germany, the name was formally trimmed to its bare initials. Admirers of its fat earnings statements (net earnings averaged 15% of revenue over the past five years) sometimes still refer to DGG as “Die Goldene Gans”—the golden goose. DGG’s annual revenues in the previous year, over €650 million (US$590 million), resulted in net earnings of €99 million (US$90 million). Erika interviewed with many people at DGG, and was specifically hired by Wilhelm Mann, who had been impressed with the depth of her technical and business experience. In her new position, Erika was to work with several of the company’s Asian suppliers who produced printer cartridges, diskettes, and other products on to which DGG put its label. While not really a marketing position, the assignment would certainly broaden her perspective. Mann had said, apparently seriously, “One reason we are hiring you is your experience with dealing with non-European cultures.” Erika was not about to contradict him, but she doubted that her experience in Austin, Texas, with country music, barbecue, and Shiner beer would have much relevance to doing business in Singapore or Hong Kong. Still, she had confidence in her personal ability to adapt to different customs and be alert to possible misunderstandings. Nothing in all of her background, however, had given her even an inkling about the business of fountain pens.

Luna Eclipse?

Erika discussed the Luna Pen puzzle with three of her new colleagues before finding someone who could explain why a letter to Heinrich Dumart should be forwarded to her at DGG. Her company had been growing quickly and many of its employees had come on board just recently. Few knew more than she did about DGG’s past, but Dieter Bauer had been there for many years and was able to provide some history.

Luna was a small company that had been owned and operated by the Dumart family for almost 60 years, Bauer had explained. Annual revenues in the 10 years between 1978 and 1988 were approximately €11 million (US$10 million). In the 1980s, when the then-senior Dumart was approaching retirement age, he sold the firm’s stock to a larger stationery company, though he stayed on to manage the pen business. Three years later, in turn, DGG acquired that stationery company as a vehicle for manufacturing and marketing copy and printer paper. Luna was not central to the deal, and DGG had made some efforts to spin it off. With the death of Herr Dumart several months earlier, and Luna showing annual losses, there was little interest. “Luna is in corporate Valhalla now,” Bauer said. When Erika did not seem to understand his reference, he explained that Luna was now in whatever afterlife companies experience when they die. “We tore down the little factory where the pens were made on the other side of the city maybe five or six years ago.

There’s a warehouse there now. If Luna Pen exists today, it’s just on paper.” Erika nodded with a slight smile. Bauer was from Bonn and seemed very formal, but perhaps his word play was intentional. “But why did this matter end up on my desk?” she asked. “Oh, that’s easy,” he replied, “You’re our new expert on the mysterious Orient.” Now Erika felt comfortable enough to respond, “Maybe no one else new wanted to be bothered with the problem.” “That may be true,” Bauer agreed, “and as the newest person here, you can’t bump it to someone else.” That reality gave Erika little comfort.

Erika was tempted at first to write Cecil Armstrong and simply tell him that Luna had gone out of business years ago, but she remained puzzled by the fact that he was somehow still getting supplies from Alven Feng of Global Service. Erika did not want to get deeply distracted by this small transaction, as she was about to leave for her first trip to Asia. Out of courtesy she wrote Armstrong, acknowledging his letter and apologized for the delayed response. She explained that Luna had been acquired by DGG and that she had “only recently assumed some responsibilities” in its regard. She thanked him for his kind words about the product and promised to contact him again after she had a chance to look into things.

Luna Rising?

One week later Erika was in Malaysia, having just finished an exhausting round of meetings with several of DGG’s suppliers there. With other meetings to prepare for in Hong Kong and Seoul, and flight delays out of the Kuala Lumpur airport, the Luna puzzle was the furthest thing from Erika’s mind when she happened to spot a handsome indigo pen in the display at the duty-free shop. “Please show it to me,” she asked the clerk. The dark blue box had LUNA written on it in discreet gold letters. Inside, there was a set of directions for filling the pen and a warranty which identified 3

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Global Service of Taipei as the repair facility. Erika carefully looked at the pen itself. To her eye, it seemed identical to the one her grandmother had given her. There on the golden nib was the familiar word, Luna.

The clerk mistook Erika’s scrutiny for dissatisfaction and perhaps inferring too much from the fine quality of her suit, said, “I think you would like better this special edition Hemingway by Mont Blanc.” The clerk offered the impressive red pen almost as if it were a religious artifact, but Erika barely gave it a glance.

“No, no. I’m sorry. I want the Luna,” she said. The look of disappointment on the clerk’s face was obvious. The Luna was priced at €47 (US$42), while the Hemingway was ten times as much, but it was clear that Erika knew what she wanted. It was clear to Erika, as well, that she had just solved the mystery of the fountain pens: she was buying a counterfeit. Mr. Feng—or somebody behind him—had neatly stepped into the vacuum that had been left when DGG tore down the Luna factory.

Erika felt a flash of exhilaration and indignation. How dare someone appropriate her company’s good name and property! Then she laughed at herself. “I’ve barely worked for DGG a month,” she thought. “How quickly one develops loyalties. Perhaps instead I should ask how we overlooked the potential value of the Luna brand name.” According to Armstrong’s letter, the pen enjoyed some popularity in Australia, and here it was in faraway Malaysia, too. Erika’s flight was called and she was on the plane to Hong Kong before she realized that she should have asked the clerk where the shop got the pens, though the warranty slip suggested that Global Service was a likely answer. When she finished her appointments in the city, she went on an exploration of local stationery stores. The first two had heard of Luna, but did not stock them, but a third shop had a good supply. Here the price was equivalent to €59 (US$54), but after only a moment’s hesitation, Erika bought an identical twin of the fountain pen she had purchased in Kuala Lumpur two days earlier. It, too, carried a warranty from Global Service. Erika took care to obtain a detailed receipt. For good measure, she also bought a bottle of Luna brand ink. In Seoul, the last stop of her trip, she set out on a similar expedition, though this time without success. One older shopkeeper remembered the Luna quite well. “Oh, yes. Made in Germany. Not so expensive. But you can’t get them any more.” Apparently Feng had yet to tap the Korean market.

DGG’s Options

On her return to Frankfurt, Erika wrote a detailed memo to Wilhelm Mann summarizing the results of her scheduled meetings. She added a short postscript stating, “I’ve come across some interesting information on the Luna matter you referred to me.” Two days later she met with Mann who was quite impressed with her general report. After the scheduled topics had been covered, Erika reached into her handbag. “I picked up a couple of souvenirs that you might like to see. This one is from Malaysia,” she noted as she slid a small blue box across his desk, “and here is its twin from Hong Kong.” Mann opened the first one in puzzlement, then the second. When he spotted the Luna name, a smile of recognition broke over his face. “So it’s a fine little company we have, Luna. No factory, no workers, no inventory, but somehow we still produce fountain pens. And, look, now we are making ink, too!”

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Erika showed Mann the correspondence with Cecil Armstrong in Brisbane. Her letter in response had only been intended to buy a little time. Some mysteries had been resolved, but a lot of questions remained unanswered, not the least of which was the identity of Alven Feng and Global Service. Before investing any serious effort, Mann suggested that they review DGG’s options. “Let’s just say we confirm that Global Service has made a tidy little business selling counterfeit Lunas. What should we do about it—if anything?”

Erika had anticipated the question and imagined several alternatives. “My first reaction,” she admitted, “was to bring a lawsuit for violating our trademark, though I expect that might be expensive and time-consuming. Of course, we always could use the threat of a suit as bargaining leverage.”

“Check with Gunther Schmidt in our legal department,” Mann interrupted. “We need to know where we stand in that regard.” “Also, we’d need to think about what such a suit would get us,” Erika continued. “I suppose we might collect royalty damages, but putting Global out of business doesn’t really help us in any way— unless we want to get back into fountain pens.”

“I can’t see doing that,” Mann mused. “It’s just too far removed from our core business. We didn’t make anything of Luna when we had it and the big accounts we serve today buy printer ribbons by the truck load. They’re not asking for fountain pens. Am I wrong?” Erika did not feel she knew Mann well enough to challenge such a statement directly. Moreover, she suspected that he was probably right on this issue. Still she told him about some quick research she had done on the fountain pen market. Most of the sources she was able to find through LEXIS/NEXIS described the burgeoning market in the United States, though clearly fountain pens were reappearing everywhere. Annual sales in America had bottomed out at 6.4 million units in 1978 after the onslaught, first, of ball point pens, then felt tips.

But the trend reversed itself in the 1980s, notably with the sales of luxury writing instruments. In 1990, 25.5 million fountain pens were sold in the United States. Germany’s own Mont Blanc apparently had half of the American high-end market, Erika added. Overall sales continued to grow, more than doubling since 1990. “So Luna got out—not in—on the ground floor?” Mann asked. “It would seem so, yes,” Erika said. “Luna would probably be in a niche with Osmiroid, Platignum, and some of the lower-priced Parkers. I don’t have any sense of production costs, but it certainly looks as if these companies are doing very well. Even if it’s not the right business for us, Luna may well be valuable to someone else.”

Mann thought for a moment, then neatly arranged the Luna boxes side by side on his desk. Even if DGG could find someone else to manufacture the pens, he speculated, he still worried that his company was poorly positioned to promote and distribute them. “Let me check that option with some other people here, but I don’t think we want to be in the fountain pen business.” With the hour growing late, the two of them quickly sketched some options. First, DGG could bring suit against Feng and Global to recover damages for past trademark violations. Second, it could negotiate some sort of settlement with Feng in respect to prior royalties and the right to future use of the Luna name, either through some sort of on-going licensing arrangement or an outright sale. Third, of course, DGG might find some other enterprise that would be interested in buying Luna’s goodwill.

“Would you be willing to handle this?” Mann asked.

Erika was delighted at the prospect of having a project that was entirely her own, though Mann cautioned her not to get too deeply entangled. “We have much bigger things on our agenda. Anything you can get out of this will be a windfall.”

DGG’s Legal Position

Within the week, Mann confirmed that his superiors did not want to resurrect its fountain pen activities, though DGG would be glad to get whatever value was represented by the Luna name. In the meantime, Erika had also received a written legal opinion from Gunther Schmidt. He had found the old Luna files and confirmed that the Luna name had been duly registered internationally, though he cautioned that this might have more significance in Europe and North America than in certain Asian countries. Countries that once were notorious for counterfeiting, he noted however, were now starting to crack down—in order to become better trading partners—but there still were some differences from place to place. In particular, he added, there might be a question of whether the Luna name had been “abandoned,” and thus could be appropriated by another company. Although DGG had never formally dissolved the Luna firm, the reality was that it had been out of business for several years.

There were practical problems of greater concern, he added. First, in a typical trademark violation case, the complaining party measures its damages in terms of lost market share and tarnished reputation. As DGG had voluntarily left the market, could it really be said to have lost anything? There was still the possibility that some sort of punitive damages might be won. Second, prosecuting such a suit would be expensive, Schmidt warned. It would be necessary to hire local counsel, perhaps in each of the countries in which the Lunas were being illegally sold. The advocates would want to be paid up front, while any award—and subsequent collection—of damages could take years. And should DGG not prevail in court, it might be liable to pay the legal costs of the winning parties. On the other hand, Schmidt acknowledged that the threat of litigation might be the only way of bringing Feng to the bargaining table.

Erika was not surprised by the tone of Schmidt’s memo, though it deepened her realization that she was not in the strongest bargaining position, either with Global or with other potential buyers who might be worried about the legitimacy of the Luna name. Schmidt had offered no support for an aggressive legal campaign to vindicate DGG’s rights, nor could Erika herself recommend such action, at least not at the outset.

The situation seemed to call for some negotiated solution. To that end, Erika got authorization from Mann to hire an investigator in Taipei to learn more about Global Service and Alven Feng. It took several weeks to find someone in Taipei to prepare a report, and then another two before the information was on Erika’s desk. She learned that Global Service was a legitimate company founded in the late 1950s in Taipei by the Feng family. It was still privately held, so financial information was not available, but knowledgeable observers estimated that its trade activities were in excess of €23.2 million (US$21 million) annually. Profit figures were even harder to obtain, but the investigator suggested that the usual return for this type of firm was between 8% and 13% of revenues. Global had done some limited manufacturing over the years, but typically acted as the middleman, distributing other companies’ products. At the outset, Global had opportunistically traded in small goods to America; in the 1970s, for example, it was very active in the export of toys made in Taiwan and elsewhere. It was now out of that business entirely; with growing prosperity in the Pacific Rim, it had turned east to do its business.

One of its more lucrative activities was said to be the Asian distributorship of Luna pens, which it both manufactured and distributed. Without providing an exact figure, the investigator estimated that Luna pens and other Luna brand products accounted for approximately one-quarter of Global’s sales. Alven Feng, the report concluded, was the 58-year-old managing director of Global and eldest son of its founder. Other family members were involved in the business, including a brother based in Malaysia, but Alven Feng was said to rule the enterprise with an iron hand. A recent newspaper article on the company, which included a photograph of Feng receiving a community service award, was attached. The copy was not good and Erika could only make out the image of a serious looking man, a bit stout, wearing glasses. The translation of the article itself provided a laudatory account of Feng’s public service and speculated that Global, with large cash reserves, was poised for a major expansion.

Preparing to Negotiate

Erika needed to make another trip to Southeast Asia on other important business. At some point, it would be necessary to deal with Mr. Feng and Global Service and now seemed to be as good a time as any. “But how should I start the discussions?” she thought to herself. From her days in Texas, she remembered the American saying, “shoot first, ask questions later.” Maybe she should have Schmidt retain a Taiwanese lawyer to file a trademark suit, even if she didn’t plan to prosecute it fully. She was confident that she could win Schmidt’s and Mann’s support for this strategy, particularly if it seemed like the only realistic way of getting Feng’s attention. Or perhaps she should not start so aggressively. She drafted several different letters for comparison. One summarized the Luna situation as she understood it and threatened legal action if Global did not pay damages for past infractions. Another version was more conciliatory in tone and hinted at a possible joint venture. Still another said nothing about Luna pen, but suggested that in light of DGG’s growing Asian presence, she wished to discuss a possible relationship with Global to handle computer products.

Erika thought fleetingly about whether there was any way or advantage in having Alven Feng come to her, so she would be operating on familiar territory. Perhaps that might happen at some stage, but she decided that there was more to be learned about Global from being on site. Back when she had been interviewed for her new position at DGG, Wilhelm Mann had flattered her ability to deal with people from other cultures and she had not demurred. Her recent trip to Asia on other business had been merely introductory; ideas were explored, but no firm agreements were negotiated. This time Erika would likely have to make a deal with Feng and any others who might be involved. She was not comfortable with the fact that she knew little about him, and even less about how he bargained.

In her apartment, Erika had cartons of books that she still hadn’t unpacked from her time in the United States. Among them were some negotiation texts and books on working in unfamiliar cultures. She had greatly enjoyed browsing in the bookstores of Austin. With the best of intentions Erika had picked up things that she meant to read but too rarely had the chance to open. Now it was time to do some research.

One book1 included a collection of short “dialogues,” many of which demonstrated how easily people from different countries could talk past one another and not even know it. Erika scanned the 1 Craig Storti, Cross Cultural Dialogues: 74 Brief Encounters with Cultural Differences (Yarmouth, Maine: Intercultural Press, 1994). pages quickly for conversations with the Chinese. One particularly telling example had a westerner insistent on getting down to the “basics” of the detail at hand while her Chinese counterpart wanted to talk at length about the history of both companies.

Another book on differences in body language warned that when the Chinese “suck air in quickly and audibly around the teeth,” it is a sign that you should modify your request “rather than risk having your Chinese counterpart face the highly embarrassing (for them) situation of having to say ‘no.’“2 Silence, she read, could be a sign of polite contemplation, but direct eye contact was uncommon.

Were such rules of behavior and communication always accurate, Erika wondered? She recalled that when she was in Austin, various well-meaning classmates had remarked on how much more friendly and outgoing she seemed than most Germans. “Well, the people from the north are more formal,” she had usually explained, ”but I’m from Munich and we’re much more outgoing.” Reflecting on her own experience, she wondered if people were wrong when they stereotyped all Germans, what could she confidently expect to know about anyone else just from their nationality? Erika read further and found a few useful observations. Nevertheless, her research left her less confident than when she began. How should she initiate a meeting with Alven Feng? Should she be aggressive or conciliatory? Would her being female have any bearing on the negotiation? Erika’s schedule called for her to be in Taipei in exactly one week. For a brief moment, she regretted ever having opened up the Luna question. A simple bureaucratic reply to Mr. Armstrong would have ended the matter and spared her all this uncertainty. She quickly regained her resolve, however, remembering Mann’s comment that anything she won from Alven Feng and his Global Service would be a pure windfall. Still, this would be the first deal she had made for DGG and she wanted to make a good impression.

Erika centered several sheets of unlined paper on her desk, removed the cap from the pen her grandmother had given her, and began to sketch her negotiation strategy.

2 Roger E. Axtell, Gestures: The DO’s and TABOOs of Body Language Around the World (New York: John Wiley & Sons, 1991).

Assignment

This background material brings Erika Graeper to the point where she had to make some key decisions. Going forward, this case asks you to step into her shoes and deal with the issues as they develop.

Before reading the last page of this case, please take several minutes to outline a negotiation strategy. If you were in Erika’s position, for example, what steps might give you the best chance of achieving your goals? What further information might you need before contacting Feng; and how might you realistically obtain it?

After outlining your strategy, please read the scenario on the next page and tentatively choose one of the options which is offered. In our next class session, we will discuss the possible advantages and drawbacks of various options. You will then learn what Erika herself did in this situation and what transpired next.

LUNA SITUATION 1

Imagine you are Erika Graeper. What would be your initial approach to the negotiation with Alven Feng?

Please read the alternative approaches listed below. Although none of the alternatives may be exactly what you would do, circle the letter (A, B, etc.) of the approach that you would be most likely to take if these were your only options. Next, select the one you would be least likely to take, and put an X over the corresponding letter.

A. Fax Feng requesting a meeting with him in Taipei next week. Outline your understanding that Global Service Company has built a considerable business using the Luna name without DGG’s permission. Raise the issue of back payments for past misuse of the name, and a possible license or sale for future use.

B. Write Feng that his company must cease its unauthorized use of the Luna name, and that DGG is prepared to file lawsuits if necessary. Unless your company asserts its rights, Feng has no reason to negotiate.

C. Contact other companies in Southeast Asia that might be potential buyers of the Luna name, in order to determine their possible interest. Also, write Feng and tell him DGG is planning on selling the rights to the Luna name. Request that he come to Frankfurt in the near future to discuss the settlement of this matter.

D. Fax Feng, introduce yourself, and tell him that you will be in Taipei next week. Ask if there is any convienient time to discuss your recent discovery that the Luna pen is selling well in the Far East, under his company’s marketing strategy. Let him know that DGG is interested in some form of partnership with Global Service.

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