Industrial Equipment Inc

It was a beautiful June evening in 1990 but Jim Costello, President and Founder of Industrial Equipment Inc of Saint John, New Brunswick, was not able to enjoy it. He was still in his office after another hectic day; supper would have to wait. Jim was considering whether he should try again to buy one of his competitors, Hines Equipment Limited, located in Prince Edward Island. Jim had been in this situation three times before, almost closing deals with Ron Hines; but at the last minute Ron always backed out. This had caused ill-will between the two and a rift in the family, as Ron Hines was Jim's father-in-law.

Company Background

Jim Costello established Industrial Equipment Inc in 1986 after several unsuccessful attempts to acquire his father-in-laws business. Industrial Equipment sold and serviced a variety of industrial equipment and related products to hospitals, nursing homes, hotels, motels and various other organisations in the four Atlantic Canadian provinces of New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland and Labrador.


This case was prepared by Robert G Blunden of Dalhousie University for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Some elements of this case have been disguised.

Copyright 1992, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.


Products, Services and Markets

In addition to distributing a broad line of specialised industrial equipment and related products in Atlantic Canada, Industrial Equipment provided design, specification and planning assistance to architects, builders and owners designing new facilities or renovating existing operations. Industrial Equipment also installed the equipment it sold. The firm maintained an extensive parts inventory and provided a complete repair and maintenance service for its customers.

Industrial Equipment did not have its own service department; instead it subcontracted the bulk of its repairs, maintenance and installations throughout Atlantic Canada to Metro Service, a Saint John firm. Occasionally Industrial Equipment used other local service firms. This arrangement had permitted Industrial Equipment to grow and offer service to its geographically dispersed customers, something not all of its competitors did, without the expense of a service department. But, it was not completely satisfactory. Jim had less control over the service function than he would have liked; especially as he considered superior service to be one of the keys to long run success. And while customers called Industrial Equipment for service, when the serviceperson arrived he was from another firm. Jim knew that Brian Hudson, the owner and commercial service technician of Metro Service, had been soliciting several of Industrial Equipment's customers directly to save the 20% discount he offered Industrial Equipment.

Operations

Since its inception in 1987, Industrial Equipment had experienced significant growth in sales and profits (See Exhibits 1 and 2 for the firm's financial statements). Jim expected the growth trend would continue.

This had been accomplished by Jim Costello and a staff of three: an assistant, a secretary and a combination partsperson/dispatcher. Jim was responsible for the day-to-day management of the firm, its long-term direction and equipment sales. Selling activities required that he spend about half of his time travelling Atlantic Canada. Jim's assistant, his wife Laura, helped him with special projects and handled equipment sales in his absence. Angela Stanbury, the secretary, performed all of the usual reception and secretarial tasks and maintained the accounting records. Ralph Stock coordinated parts and service. He ordered parts, handled parts sales, dispatched service technicians and maintained the parts inventory.

The organisation was small and close knit; the work atmosphere was friendly and up beat. They functioned well as a team. Everyone knew much of each other's jobs and they readily helped each other as necessary. Jim felt the team was a crucial component in Industrial Equipment's success and had recently instituted a bonus plan to help make each team member feel a part of the business and its success.

Strategy

Jim's strategy was to sell quality industrial products at competitive prices and to back those products with prompt, effective service in Atlantic Canada. He saw service as a key strategic variable that differentiated Industrial Equipment from its competitors. Industrial Equipment was the only firm in the region that offered a facility design service. Industrial Equipment and Hines were the only equipment distributors that focused on after sales service as well as equipment sales.

He wanted to see the business grow through expanded operations and selective acquisitions. The desire for growth and concern over his lack of an in-house service operation had led Jim to propose the merger of Industrial Equipment and Metro Service. Jim suspected that Industrial Equipment represented about one-third of Metro's business and that the proportion was growing as Industrial Equipment grew. He also thought that there were significant opportunities to improve the combined operations. Overhead could be reduced as Industrial Equipment could easily absorb Metro's accounting, billing and dispatching functions, which would eliminate one position in the process. Jim also felt management could be improved at Metro Service. While Brian Hudson, Metro's owner, was an excellent technical person, Jim thought he was a poor manager.

Jim had proposed a deal that he thought offered Brian more personal income for less effort and fewer problems; but Brian did not want to sell. He valued his independence too much. However, to increase the cooperation between the firms and improve customer service, Brian moved Metro Service into the same building as Industrial Equipment and Jim stocked Brian's service truck with parts at Industrial Equipment's expense.

Jim Costello

Jim had grown up in a family business, owned and operated by his father. Like all the children in the family, Jim began working for the company at an early age. He started doing odd jobs evenings and weekends during high school and he worked full time during the summers. After graduating from high school, he pursued a university degree in business, but quit in his third year. That night his father offered him a job, and while Jim was proud, he was not too proud to take the job.

Jim's journey into sales was accidental. He was responsible for assembling a display for his father's exhibit at an annual trade show. The company was short-staffed and he was knowledgeable about the products so he stayed to work in the booth. By the end of the show he had closed three large deals and decided he enjoyed sales. Soon after, he became a sales representative for the firm.

Jim developed his natural selling ability and eventually left to manage a land development company for the father of his fiancee, Laura Hines. However, the local housing market turned sour and they closed the business. Still, Ron Hines recognised Jim's sales ability and offered him the position of sales manager at Hines Equipment. Jim moved to Charlottetown, Prince Edward Island to work for Hines Equipment in May 1981. Shortly after, Jim and Laura were married.

In the years that followed, Jim learned the industrial equipment business and was so successful that by 1985 his sales accounted for over 80% of the company's total revenues. His territory was New Brunswick and Newfoundland but he also assisted part-time representatives in Nova Scotia.

In January 1983, after a serious disagreement with Ron Hines, Jim moved back to Saint John and opened a branch sales office for Hines Equipment at his own expense, working for straight commission. He continued to improve the company's business position by expanding the product line with 25 related products. During the first year of business in Saint John, sales were $240,000; by 1985, sales exceeded $900,000.

The Industry

Market Size, Growth and Trends

Little hard data was available on industry sales because most distributors were privately held and guarded their performance results carefully. Similarly, most industrial equipment manufacturers were either privately held or were divisions of large diversified firms who did not provide segmented performance results in sufficient detail to determine their sales in the product categories in which Industrial Equipment was active. The matter was further confused by the wide range of industrial equipment, the limited lines distributed by any one firm and the overlap of lines that existed between firms. Historically, the bulk of Industrial Equipment's sales had been made to hospitals, nursing homes and hotels and Jim had collected some data on the approximate sizes of those market segments in Atlantic Canada (over).

 

Beds in Atlantic Canada
Nursing Hotels/
Hospitals Homes Motels
Newfoundland 4,115 2,569 4,617
New Brunswick 5,481 4,218 9,010
Nova Scotia 5,899 2,760 9,441
Prince Edward Island 1,037 538 2,988

Sources: Canadian Hospital Directory 1989-90; Directory of Long-Term Care Centres in Canada 1990-91 and 1991 provincial travel guides.

Industry watchers forecast slow overall industry growth roughly in step with population growth trends. Other industry trends included increasingly streamlined and specialised operations using more equipment and automation to substitute for hard to find, expensive labour. Noise reduction and energy conservation were becoming increasingly important equipment issues as well.

Competition

Industrial Equipment had four main competitors and several smaller competitors in Atlantic Canada. The main competitors were Hines Equipment in Charlottetown, Prince Edward Island; Sam Reid in St John's, Newfoundland; Quebec Equipement Ltee based in Montreal, Quebec and Equipment Distributors in Halifax, Nova Scotia.

Hines Equipment was the business owned by Jim's father-in-law, Ron Hines, that Jim was interested in acquiring.

It was established in 1961, with its head office in Charlottetown, Prince Edward Island. Hines distributed industrial equipment in the four Atlantic Provinces, primarily to hospitals, nursing homes, institutions and hotels/motels. In many ways Hines was Industrial Equipment's most direct competitor. Hines and Industrial Equipment both represented the leading industrial equipment manufacturer; they both covered Atlantic Canada and they both viewed service as a key aspect of their business.

Sam Reid, formerly a sales representative for Hines Equipment, was currently working for himself in Newfoundland. He sold supplies and represented several equipment manufacturers in Newfoundland. Jim thought that Sam had developed a substantial market share in Newfoundland and he had considered proposing some form of business arrangement to him but he was uncertain as to whether or not he could work with him. Quebec Equipement, in Montreal, Quebec, sold many of the same lines as Industrial Equipment and Hines Equipment and would occasionally price large orders very aggressively. They could do this in part because they had no local presence or costs and seemed to view Atlantic Canada as incremental business. In addition, Quebec Equipement had a broader product line than the Atlantic based firms. For example, Jim thought they had 60% to 70% of the related industrial equipment market in the food service sector, the next market Jim hoped to penetrate.

Equipment Distributors, a Nova Scotian firm located in Halifax, dominated the lower end of Atlantic Canada's industrial equipment business. Jim believed that much of their success came from the principal product line they represented, which was highly demanded by smaller, cost-conscious customers. This producer only made smaller equipment, but Equipment Distributors also handled some commercial lines, including one represented by Quebec Equipement. Jim believed that Equipment Distributors might lose that line because Quebec Equipement was pressuring the manufacturer to have only one distributor and Equipment Distributors was not selling their product line as aggressively as Quebec Equipement.

Other competition which Industrial Equipment faced came from two sources. About five smaller distributors in the region offered occasional competition, usually only on certain product categories. Another more serious source of competition came from the centralised purchasing departments of larger hotel chains. They often had direct purchasing arrangements with manufacturers through their US operations. Industrial Equipment had very little control over the purchasing decision in these cases.

The Opportunity

Hines Equipment

Hines Equipment was established in Charlottetown, Prince Edward Island in 1961 by Ron Hines to distribute industrial and commercial equipment throughout Atlantic Canada. Over the years, the sales level and the sales mix had varied significantly, depending upon the focus and resources of the firm. Ron Hines' primary interest had always been in developing the parts sales and service aspects of the firm, because they had inherently more attractive margins, less competition and addressed an existing market. Whatever equipment sales he could capture were welcome additional revenue as long as the margins were healthy However, between 1982 and 1986, Jim had expanded the firm's equipment sales dramatically with more aggressive sales efforts and prices. After Jim left Hines Equipment in 1986, equipment sales declined while parts and service revenues regained dominance.

Ron's emphasis on parts and service and Jim's focus on equipment sales was formalised over time as they sorted out the distribution rights to Abbott Equipment, their anchor line of industrial equipment. As soon as Jim had established Industrial Equipment in 1986, he approached Abbott for the rights to distribute their products in Atlantic Canada; the rights that Hines Equipment had had for almost thirty years. Abbott, another family business, did not want to lose Jim's aggressive sales efforts, nor did they want him selling competitors' products so they made an exception to their standard policy of one distributor to a region. In this case, Hines Equipment and Industrial Equipment would share the region. Jim focused on equipment sales and Industrial Equipment's equipment sales increased at Hines expense. In 1988 Ron came to Jim with a deal: since Ron did not want to compete directly with Jim, Ron suggested that Hines Equipment handle Abbott parts sales and Jim sell Abbott equipment. Jim agreed and they formalised an arrangement whereby Industrial Equipment bought its parts from Hines while Hines bought its equipment from Industrial Equipment. Financial data for Hines Equipment (1987- 89) is presented in Exhibits 3 and 4.

In 1990, Hines Equipment had five employees. Ron Hines was the company's president, general manager and sales force. His wife, Lois, was secretary-treasurer to the firm and maintained the business records. Jane Wilson was the secretary and receptionist. Carl Lamont and Frank MacIssac were service technicians and parts salesmen. Normally one of them was on the road handling service calls while the other staffed the parts desk at the office. This was advantageous to the firm because it meant that most parts orders were handled by a trained service technician who could help the customer over the telephone and yet, when necessary, both men could handle service calls. To ensure that flexibility both Carl and Frank had fully equipped service vans.

Past Attempts to Buy the Business

Jim had tried to purchase his father-in-laws business several times before. While it had been Ron Hines that initiated the idea of Jim and Laura buying the business, some impediment always prevented the final execution of the sale. Perhaps Ron Hines just could not bring himself to sell the organisation he had built.

The first time Jim tried to purchase Hines Equipment was in 1982. At the time Jim was earning substantial commissions on his growing sales but he kept them in the business, taking only a regular monthly salary. Nevertheless, Jim did not have enough money to purchase the business outright, so he suggested a payment plan over time. Ron rejected Jim's offer.

In 1984, Jim made a second attempt to purchase Hines Equipment as his relationship with Ron had deteriorated. Unable to finance the purchase himself, Jim approached Quebec Equipement, the Montreal based competitor, and negotiated a deal which would see Quebec Equipement, provide financing in exchange for 45% ownership of the company Jim would hold 55% of the firm and become president. In addition to making it possible for Jim to acquire Hines Equipment, the joint venture had two other advantages. Involving Quebec Equipement, would reduce competition in Atlantic Canada and Quebec Equipement's extensive experience in food service equipment could be transferred to Hines. Before long, Ron Hines was dealing directly with Quebec Equipement, in an effort to sell them the business. The deal fell through eventually and Jim realised it was time to leave the company.

In 1983, Jim and Laura decided to move back to Saint John, Jim's home town, but the day before they were to move Ron asked Jim to stay with Hines Equipment. Jim, willing to give it one more try for the sake of family relations, said that he would stay with Hines Equipment but only under very different terms. The two agreed that Jim would operate a Saint John office, earning a straight commission of 10% on his sales and pay all of his own expenses. Jim liked this arrangement because it Put some distance between the two men and it also allowed Jim to stay in the industrial equipment industry. This arrangement worked so well that by 1986, Hines Equipment owed Jim $60,000 in commissions as Jim had continued his practice of withdrawing from earnings only what he needed for current expenses.

A third purchase agreement was initiated in 1986, but this time things appeared to be much more serious. Ron wanted $200,000 in cash for the shares of the company with no payment terms. It took Jim eight months, but he eventually arranged complete financing and an agreement of sale was signed by both parties. But this agreement too was destined to fail. Ron had recently disposed of a company vehicle and at the legal closing of the sale Jim's lawyer made an adjustment to the agreed upon purchase price to reflect the vehicle sale since the purchase agreement indicated that there were to be no changes in the assets of the company. This upset Ron and he left without completing the sale. In desperation, Jim reminded Ron that if he did not return to negotiate, he would have to release all of the commissions; Hines Equipment owed him. If he did not pay, Jim said he would take legal action.

Eventually, Jim sued Hines Equipment for $120,000, which represented commissions, lost revenues, and professional fees incurred. Jim won the suit and was awarded $110,000, to be paid in monthly instalments over two years. After the court case, Jim offered to settle the matter for an immediate lump sum payment of $90,000 to put the whole matter behind them. Ron accepted.

Soon after, in 1986, Jim made yet another offer to buy Hines Equipment, this time advising Ron that if he were not able to buy the business he would start a rival firm. Ron refused to sell and Jim opened Industrial Equipment Inc.

A Time for Decision

Now, Jim was facing a similar situation once again. Ron had approached Jim to buy his business. This time, Jim thought, the deal might just go through. Ron was 63 and ready to retire. Things were different, too, in that Jim's company had taken away much of Hines' business. Hines 1989 sales had fallen to about $481,000 and 1990 performance appeared to be shaping up similarly; total sales for the first two quarters were about $223,000.

A familiar situation and a familiar question. Jim was not sure how to handle either. Should he ignore the possibility of adding to Industrial Equipment with the acquisition of Hines Equipment, or should he try yet again to strengthen his own company while risking another family quarrel?

Exhibit 1

Industrial Equipment Inc
Income Statement
Year Ended April 30

1 Includes about $36,800 of installation expenses.

Source: Audited financial statements.

Exhibit 2

Industrial Equipment Inc
Balance Sheet
April 30, 1990

Source: Audited financial statements

Exhibit 3

Hines Equipment Inc
Income Statement
Year Ended August 31

Source: Audited financial statements

Exhibit 4

Hines Equipment Inc
Balance Sheet
August 31, 1990

Source: Audited financial statements.