STRATEGY SKYLINE CHILI: A CASE FOR SMALL BUSINESS GROWTH AND MANAGEMENT Daewoo Park Bema A. Krishnan Xavier University ABSTRACT Skyline Chili produces the secret-recipe chili for its restaurants and severe/Pozen chili productsfor local grocery stores in Cincinnati, Ohio and other areas. An interview with Mr. Kevin McDonnell, new CEO ofSkyline Chili in the case discusses the past present, and future ofthe company. Can the company sustain its growth and competitivenessin the /990s? /f so, what can you recommend for the company? SMALL BUSINESS GROWTH AND MANAGEMENT Small businesses account for more than half of total US. workforce and over eighty- seven percent of employment growth in the past decade. They also embrace ninety-seven percent of the enterprisesin the U S. Thus, small businesses are truly the mainstay of the U S. economy (Handbook of Small Business Data, 1988). Recognizing the preponderance and relative impact of small businesses as major contributors to job creation and economic growth, academic research on small business management practice has grown dramatically over the past decade. In particular topics of'strategic growth'f small businesses have received much attention from researchers (Bygrave, 1994; Jennings, 1994). Presenting the past and present of Skyline Chili, therefore, this study examines the topic of small business growth and management. 0'farrell and Hitchens (1988)examined the alternative models/perspectives of small business growth and tried to find the characteristics of successfully growing businesses. Portraying the characteristics of successful small businesses, they emphasized that small businesses should be able to identify the key criteria upon which to compete in certain segments. Then they must build a competitive advantage based upon these criteria. According to them, many small businesses employ different types of growth strategy as a way to achieve their competitive advantages. Previous literature on small business growth has yielded three groups of studies: (1) a group of studies examining the relationship between certain management/organizational characteristicsand business growth(Bracker, Keats & Pearson 1988; Covin 1991;Lyles, Baird, Orris, & Kuratko, 1993); (2) a group of studies examining the relationship between management/organization characteristics and various stages of growth (Birley & Westhead 77 1990; Hanks 1990; Kazajian & Drazin 1989); (3) a group of studies examining the relationship between the dynamics of growth and various aspects of management of that growth (Fombrun & Wally 1989; Shuman & Seeger 1986). Using an interview with a small business executive as well as secondary sources of information (annual reports and industry data base), the current study attempted to reveal the relationship between management and small business growth. Merz and Sauber (1995) provide several reasons why it would be appropriate to investigatethe managementactivities(includinga formulation and implementation of growth strategies) of executives in small businesses. First, it extends the 'upper echelons perspective'rguing that a firm's strategic, structural choices and performance levels are inlluenced by top managers'characteristics(Hambrick and Mason 1984). Second, it is consistent with the trend in small business research emphasizing the executives'ehaviors and activities instead of their personal characteristics (Stevenson and Jarillo 1990). Third, the use of managerial activities as a predictoror an indicatorof future strategy has a greater applicabilityin understanding the strategic growth and success of small businesses (D'Amboise and Muldowney 1988). SKYLINE CHILI, INC. Skyline Chili Inc. was founded in 1949 by the I.ambrinides family. Nicholas Lambrinides, a former cook for railroad workers and native of Kastoria, Greece, used his culinaryexpertiseto open the chili restaurant in downtown Cincinnati. Today, Skyline Chili produces the secret-recipe chili [see Exhibit I] for its restaurants and several frozen chili products for local grocery stores. "Cincinnati-style" chili is defined by its presentation: a plate of spaghetti with sauce and shredded cheddar on top. Native Cincinnatians know it simply as a "3-Way." lf onions are added, it's called a "4-Way." The addition of beans makes it a "5- Way." Skyline restaurants are located throughout Greater Cincinnati and in Dayton, Indianapolis, Louisville, Indianapolis and Columbus. The company also operates five restaurants in Florida, including two in Ft. Lauderdale and one each in Clearwater, Ft. Meyers and Naples. Of'the 82 Skyline storesoperating now, 30 are company-owned, and the rest are franchises. Skyline Chili opened its first franchised store in 1958. Its major competitors are Empress Chili which has been in existence since 1922 and Goldstar Chili with 118 outlets. Skyline became a publicly traded company in 1986 in an offering that raised about $4 million. Skyline currently has 500 employees. Additional information such as selected financial data is provided in the Appendix. 78 Exhibit l How We Built A Legend 100% real cheddar cheese Zesty diced onionsd~~ Delicious small red beans Our secret-recipe chili made from 100% top gradec beef and spices from around the world. 100% semolina wheat flour spaghetti. INTERVIEW WITH Mr. KEVIN McDONNELL (CEO, SKYLINE CHILI) Question l: Could you give me a brief overview of Skyline's history? Mr. McDonnett Skyline began in 1949 at the Price Hill location in Cincinnati. This location overlooks the Cincinnati skyline, hence the name of the company. The first expansions came in downtown Cincinnati where it experienced good growth and success. To improve its customer base, the company expanded into the suburbs. In the late fillies, Skyline began franchising throughout Cincinnati. By 1965, the company had expanded its service by becoming a supplier of frozen products to grocery stores. Skyline's stock went public in the mid eighties at $4.50 a share and has since bounced around. Today we are experimenting with new strategies for growth outside the Cincinnati area. Question 2: When did Skyline go public and why? Mr. McDonnetk We went public in the mid eighties for mainly two reasons. first, we were looking for ways to gain furthercapital for expansion into new markets. Second, a portion of the company funds were used to retire the debt from two of the five brothers who wanted to sell their interest in the company. Question 3: What do you consider to be Skyline's greatest strength? 79 Mr. McDonnell: Our greatest strengths are the quality of our products coupled with good service. This is evident in the recent surveys where consumers rated our product quality as the primary reason for coming back. Question zfl How do you break down the business for strategic management efforts? Mr. McDonnell: We have three distinct channels of product flow. One segment is our company-owned stores which utilize; the largest amount of assets and as a result, offers the least amount of gross margin. Our second channel, the franchise segment, uses less capital and provides a higher opportunity for growth. Our third channel, the grocery store frozen food segment, is a high growth, low capital channel. Since 1990, we have been striving to maximize our strategic management efforts in afl these segments. Question 5: What are your strategies for growth for markets outside of Cincinnati? Mr. McDonnell: ln the late fiflies we had the philosophy that as a result ofhaving a great product which had proved itself in Cincinnati we should be able to sell it in any market. We had the philosophy that "ifyou build it they will come." Therefore, we entered markets such as Pittsburgh, Cleveland, Indianapolis, and Columbus. We recognized that, although there would be a desire for quality products, we could not expect the high volume that we enjoyed in the Cincinnati market. Therefore, we decided to open smaller stores in low cost spaces, such as strip mafls. We controlled costs in these locations through tight controls on marketing expenses and by excluding table service. We found this to be a mistake. Recent surveys reveal that, in addition to product quality, customer also value table service. furthermore, locating our restaurants in strip mails did not create as much awareness among consumers as we were able to create by locating our restaurants in a free standing building. "Consumer awareness. " That's our fight. That's our challenge. Question 6: How do you plan to leverage these findings in a new strategy for growth? Mr. McDonnell: We are currently focusing on expansion outside of Cincinnati through the efforts of our "Project Mousetrap." We are testing this strategy in Columbus at our company- owned stores. We are operating in free standing stores which provide both table and drive- through service. We have contracted with a design firm to create a new look which will attract attention through 'tasteful garnishment.'hey are decorated in checkerboard and outlined in neon, creating an attractive and eye-catching image. In our attempts to implement "Project Mouthtrap," we have added spaghetti with red sauce and fettucini, gyros, and hot dogs in order to attract the skeptic. These items not only broaden our product-line but also involve little additional investment by way of new raw materials or preparation procedures. The intention is to soon wean them off the odd products and sell only traditional skyline items that are ofhigh quality. Customers like the design of the new store and have begun experimenting with our chili. Although we are happy that our customers have adopted the new items, we have continued to focus on our traditional items 80 which constitute more than 85'/o of the total sales. We have no intention of diverting from the traditionalskylinemenu. We are in the businessofCincinnatichili and that is wherewe intend to stay. Question 7: Who are your major competitors in Cincinnati? Mr. McDonnell; Goldstar Chili currently has twice as many stores in the Cincinnati area as Skyline Chili. However, Skyline has a higher tratTic rate. The one thing that differentiates Skyline over the other chili restaurants is the quality of our products as our research shows. Skyline has approximately twenty-two million dollars in revenues and about sixteen and a half million in assets, of which, nine million dollars have been invested in one asset, a single food preparation facility. This new facility allows us to utilize economies of scale by processing our chili in one large process and from there distributing it to our stores or the supermarkets. In Cincinnati our chili has the second fastest turnover for frozen food items, second only to orange juice. These factors have allowed us to make a very good impact in the Cincinnati market. Question 8: How does Skyline attract potential franchise investors? Mr. McDonnelt Today the market for investors is extremely competitive. There are so many different marketing options. In order to successfully attract potential franchise investors, you first need to learn the business so that you may be a knowledgeable teacher. This means that company stores are required to test the market and learn the potential risks and niches in any new market. It also helps by allowing increased expenditures on advertising which helps attract investors. In the fast food industry there are many strategies for the mix of franchise stores and company owned stores. Subway is 100'/o franchise, whereas Bob Evans is 100'/v company owned. We desire to maintain company owned stores but realize that our future growth will greatly be increased through franchising. The price to start up a franchise is also a factor which allows investors many options. An Outback Steakhouse costs around two million dollars to begin, a McDonald's about one point two million dollars, and a Rally's eight hundred thousand dollars. Skyline is able to initiate a franchise with eight or nine hundred thousand dollars. The current strategy of our management is to maximize efforts in our three channels of product (low, company stores, franchise, and grocery, with the major growth reliance upon franchising. Question 9i Finally, could you describe your managementand leadershipstyle as well as Skyline's culture? Mr. McDonnell: When I was in MBA program, I took the MBTI (Myers-Briggs Type Indicator) test. According to the analysis,l am NT (Intuition-Thinking) type executive. That is, I tend to be possibilities-oriented, impersonal, ingenious, and integrative. However, I have tried to employ SF (Sensation-Feeling) style and blend it with my NT style in my business management. I have recognized that it is very important to be a 'Coach'(a typical characteristc of SF style) as well as a 'Strategist'a typical characteristic of NT style) in business. My colleagues, managers, and employees have also provided similar assessments. Several years ago, I attended a seminar ("The One Minute Manager" ) emphasizing the role of coach in 81 today's business environment. I learned a lot from the seminar. In managing my organization, I really want to be "One Minute Manager." I also try to develop and sustain "One Minute Management" type corporate culture for Skyline Chili. Only good corporate culture can attract and keep good employees. High employee turnover is typical in this industry. There seems to be an ever-increasing number of jobs chasing a shrinking pool of people willing to work in service environments like restaurants. While finding affordable new sites is terribly difficult with all of the chains competing for attractive locations, the real battle is over employees. That's why I introduced "One Minute Management" type culture for Skyline Chili. ASSIGNMENT QUESTIONS I. What impresses you about this company? Is it well-managed? Why or why not? Using Skyline Chili's financial data (Appendix I), analyze internal strengths and weaknesses. 2. How successful was Skyline Chili in defining the business and cratting a strategy to achieve performance objectives? 3. Can Skyline Chili executives stand the tests of time and growth? 4. What issues does Skyline Chili face in the years ahead? What would you recommend Skyline Chili do to successfully confront these issues? 82 Table I ~Ol I lti ill l Dollar amounts in thousands, except per share data Years ended October29, 1995 Octobcr30, 1994 October31, 1993 Selected Income Data: Total revenues $25,772 $24,496 $21,626 Income from operations 1,986 1,346 1,191 Net income 980 532 431 Net income per share 0.29 0.16 0.13 Selected Balance Sheet Data: Current assets $4,535 $4,889 $3,175 Total assets 19,013 18,423 16,902 Current liabilities 3,180 3,293 2,190 Total non-current obligations 6,569 6,846 7,070 Shareholders'quity 9,264 8,284 7,642 8 Table 2 Selected Financial Data I3otlar amounts in thousands, except per share data 1995 1994 1993 1992 1991 Operations: Commissary sales $ 10,331 $ 10,817 $9.809 $ 10,327 $9,792 Restaurant sales 14,231 12,507 10,646 9,914 9,278 Franchise fees and royalties 1,210 1,172 1,171 1,217 1,217 Total revenues 25,772 24,496 21.626 21,458 20,287 Income from operations 1,986 1,346 1,191 1,076 1,434 Nct income 980 532 431 327 839 Capital expenditures',484 1,537 1.845 1,517 7,586 Per Share: Net income" 0.29 0 16 0.13 0.10 0.25 Finnncinl Position: Total assets 19,013 18,423 16,902 16,409 16,812 Propeny and equipment, nct 13,825 12,876 13,056 12,599 12,736 Long-terra debt 6,100 6,459 6,799 7,114 7,970 Shareholder's equity 9,264 8,284 7,642 7,127 6,644 Ratios: Current ratio 1.43 1.48 1.44 1.61 1.52 Total liabilities to equity 1.05 1.22 1.21 1.30 1.53 Interest coverage 3.83 2.43 2.15 1.84 5.62 Restaurant Data: Company-craned 31 30 29 28 27 Franchised 52 50 49 50 51 Total restaurants 83 80 78 78 78 Other Datn: Weighted average shares 3,419 3,390 3,363 3,350 3,342 outstanding" (in thousands) Number of employees at year-end Full-time 153 167 140 139 137 Part-time 468 404 378 344 291 Total 621 571 518 483 428 84 Table 3 Consolidated Statements of Income Years ended October29, t995 October 30, t994 October3t, t993 Revenues: Sales: Commissary $ 10431,000 $ 10,817,000 $9,809,000 Restaurants 14,231,000 12,507,000 10,646,000 Franchise fees and royalties 1,210,000 1,172,000 1,171,000 25,772,000 24,496,000 21,626,000 Operating costs and expenses: Cost of sales-commissary 7,497,000 8,211,000 7,610,000 Restaurant operating costs: Cost of food and paper 3,945,000 3,569,000 3,220,000 Payroll costs 4,266,000 3,629,000 2,942,000 Occupancy and other expenses 3,078,000 2,690,000 2,292,000 Selling, general and adminstrative 5,000,000 5,051,000 4,371,000 23,786,000 23,150,000 20,435,000 Income from operations 1,986,000 1,346,000 1,191,000 Other income (expense): Interest income 92,000 93,000 96,000 Interest expense (541,000) (583,000) (607,000) Other income (expense) (7,000) (24,000) 21,000 (456,000) (514,000) (490,000) Income before income taxes 1,530,000 832,000 701,000 Provision for income taxes 550,000 300,000 270,000 Net income $980,000 $532,000 $431,000 Net income per share $0.29 $0.16 $0.13 Weighted average common and common equivalent shares 3,419,000 3,390,000 3,363,000 outstanding 85 Table 4 Consolidated Balance Sheets Years ended October 29,1995 October 30, 1994 Assets Current Assets: Cash and cash equivalents $ 1,910,000 $2,709,000 Accounts receivable 1,074,000 726,000 Inventories 1,224,000 1,043,000 Prepaid expenses 121,000 213,000 Deferred income taxes 206,000 198,000 Total current assets 4,535,000 4,889,000 Property and equipment, at cost: Land 1,469,000 698,000 Buildings and improvements 1 1,451,000 10,556,000 Equipment and fixtures 7,409,000 6,753,000 Construction in progress 61,000 52,000 20,390,000 18,059,000 Less accumulated depreciation 6,565,000 5,183,000 Net property and equipment 13,825,000 12,876,000 Intangible assets-net 501,000 534,000 Other assets 152,000 124,000 $ 19,013,000 $ 18,423,000 86 Table 4 Consolidated Balance Sheets Years ended October 29, 1995 October 30, 1994 Liabilities and shareholders'quity Current liabilities: Accounts payable $ 1,505,000 $ 1,406,000 Accrued salaries and wages 664,000 1,032,000 Accrued interest 65,000 117,000 Income taxes 101,000 Other accrued liabilities 485,000 398,000 360,000 340,000 Total current liabilities 3,180,000 3,293,000 Deferred income taxes 469,000 387,000 Long-term debt due after one year 6,100,000 6,459,000 Shareholder equity: Common stock, no par value: 5,400,000 shares authorized; issued and outstanding, 3,345,000 shares 5,267,000 5,267,000 Additional paid-in capital 19,000 19,000 Retained earnings 3,978,000 2,998,000 Total shareholders'quity 9,264,000 8,284,000 $ 19,013,000 $ 18,423,000 87 Table 5 onsolidated tatements of Cash Flows Years ended Oerober 29, i993 Ouober 3a, 2994 Ociobcr 3 i, t993 Operating activities: Net income 5980,000 $532,000 $431,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,553,000 1.373.000 1,399,000 Dcl'erred income taxes 74,000 101,000 52,000 Amortization of stock mvard Compensation 84,000 Decrease (increase)in: Accounts receivable (348,000) 403.000 11,000 Inventories (181,000) (504,000) 3,000 Prepaid expenses 92,000 41,000 (37.000) Increase (decrease) in: Accounts payablc 99,000 536,000 99,000 Income taxes payablc 101,000 Accrued liabilities (333,000) 542,000 40,000 Other-net (27,000) (66,000) (1,000) Nct cash provided by operating activities 2,010,000 2,958,000 2,081,000 Investing activities Capital evpenditures (2,484,0UU) (1,537,000) (1,845,000) Payments for businesses acquired (301,000) (295,000) Proceeds from sale ofproperty and equipment 54,000 903,000 3,000 Decrease in unexpended bond procccds 173,000 Additions to intangible assets (39,000) (47,000) (19,000) Net cash used by investing activities (2,469,000) (982,000) (1,983,000) I'inancing activities ltepayments of debt (340,000) (315,000) (300,000) Net cash used by financing activities (340,000) (315,000) (300,000) Net increase (decrease) in cash and cash equivalents (799,000) 1,661,000 (202,000) Cash and cash equivalents at beginning of year 2,709,000 1,048,000 1,250,000 Cash and cash equivalents at end of year $ 1,910,00U $2,709,000 $ 1,048,000 88 Table 7 Consolidated Statements of Shareholders' ni 'fears ended 10/29/95, 10/30/94, and 10/31/93. 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