Peruna

In April of 1989, James Gorman, President of Gorman Controls Ltd of Bonshaw, Prince Edward Island (PEI) had to decide whether to proceed with test marketing the Peruna line of skin care products. James Gorman had been looking for a business opportunity that was unrelated to his present potato warehouse ventilation business. He had secured funding assistance from a government development agency to cover a portion of the test market costs and Shoppers Drug Mart had agreed to participate in the test market. He estimated that he had already invested over $20,000 pursuing the Peruna idea, and that substantially more investment would be required to test market the products. At this time, his ventilation business was entering its busy season.

Gorman Controls Ltd

In 1982, James Gorman left a secure career with PEI's largest potato processing company, Cavendish Farms. He realised a lifelong dream of starting his own business by establishing Gorman Controls Ltd which specialised in installing computerized ventilation systems for potato warehouses.


This case was prepared by Professor Tim Carroll at the University Of Prince Edward Island for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management.

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.


Gorman Controls Ltd consisted of a small manufacturing facility in Bonshaw which employed 6 to 12 employees, depending on the season. James Gorman managed production, finances, and sales. The servicing of existing installations was contracted out to electronics companies in each market area.

In six years, Gorman Controls Ltd had grown substantially in sales to potato growers and processors throughout Maine, New Brunswick and PEI. These three jurisdictions accounted for approximately 30 million hundredweights of potato production. Most potato warehouses were constructed to store 20 to 40 thousand hundredweights and it was estimated that less than 35% of all warehouses had any type of ventilation system. In any one season, approximately 80% of all potato production was stored for two to twelve months depending on market conditions.

James Gorman believed that the market would continue to prosper as more growers recognised the benefits of installing computerized ventilation systems in new and existing potato warehouses. The benefits of the system included improved product quality and reduced weight loss from the dehydration of potatoes that normally occurs while potatoes are in storage. A reduction in weight loss of a few percentage points combined with improved quality after storage meant thousands of dollars in savings for the grower.

James Gorman estimated that in 1988 he had over 80% of the business in PEI and New Brunswick and a 60% share of the business in Maine. He knew of five competitors in the United States, but his company was the only one in Canada that included humidity control with their ventilation systems.

James Gorman enjoyed the ventilation business and was proud of his success. Each customer had different needs and this required him to deal with 25 to 30 component suppliers in order to provide the right system for each customer. The challenge was accentuated because the component technology was constantly changing.

Since the business generated sufficient profits to allow him to acquire funds for investment outside the ventilation business, James decided to search for other opportunities. He believed he should look for opportunities that would provide a more steady cashflow and that were less seasonal. The ventilation business typically involved orders of $30 to $50,000 spread over seven months of the year.

In the spring of 1988, James Gorman was introduced to the Peruna line of skin care products by staff at the PEI Food Technology Centre. He was impressed by the uniqueness of the product and believed it could meet his objectives of a product with a steady sales and cash flow. Although he had no experience in the cosmetics business, the success of his existing business and his entrepreneurial desire inspired him to investigate the venture. While attending a trade show in Idaho, he decided to meet with the owner of Peruna International.

Peruna International

Peruna International was founded in 1986 by Gary Fields, a former car salesman in Boise, Idaho. The first achievement of Peruna International was its success in researching and developing the liquid powder technology for the Peruna product line. Gary Fields had established a small manufacturing facility with his savings, the backing of two local investors and the local bank. For two years, Gary Fields was the company's only full-time management employee who supervised production, sales, and financing. Limited growth in sales was achieved through independent brokers, who peddled the product in a number of southwestern and western centres in the United States. By 1988, sales were valued at $100,000 or roughly 3,200 cases of 12 eight-ounce bottles.

When James Gorman met with Gary Fields, he found that he was prepared to offer James Gorman the exclusive licence to produce and market Peruna for the eastern half of Canada and the United States (east of the Ontario-Manitoba border in Canada and east of the Mississippi River in the United States). In return, Peruna wanted $100,000 and a royalty of 2% on sales.

Peruna International was seeking additional investors because it attributed its limited sales growth to a lack of investment in marketing. Gary Fields indicated in 1988 that the company was hiring a salesperson and a part-time media representative who were also investors. The equity investment was necessary to keep the company going and provide more funds for market development.

Peruna International had not conducted any consumer market research. Gary Fields had identified a number of independent brokers who were willing to add the Peruna line of skin care products to their list. The company's promotional material consisted of product fact sheets and a newsletter which was distributed to the trade.

There was no consumer promotion except for a low quality videotaped television advertisement. The locally produced ad had run for a brief time on the local station in Boise, Idaho.

James Gorman decided to investigate the Peruna venture because, like Gary Fields, he was enthusiastic about the uniqueness of the product. The product was unlike anything else on the market and this was immediately apparent to anyone who tried the product. James Gorman was also impressed by how simple it was to manufacture the product and the low cost of the ingredients.

Peruna Product Line

The name Peruna comes from the Finnish translation of the word "potato". All of the existing and planned products of Peruna International were made from potato starch.

The product line of Peruna products consisted of five types of skin care products; itch-soothing cream, liquid foot powder, hand lotion, liquid body powder and liquid baby powder. All product lines were sold in 18 oz/250 ml white plastic squeezable containers with different coloured logos for each product. Initial sales indicated that the largest selling item was the hand lotion with approximately 35% of total sales. (See Exhibit 1 for additional product information.)

The unique feature of the Peruna products was that each came out of the bottle as a liquid which quickly dried to a powder upon application to the skin. Consumer comments on the product referred to this feature. Consumers also noted the "silky" feeling of the product which was different from the usual oily, wet feeling of most skin care creams and lotions.

Peruna International indicated that it was sure that the products were a sun screen, but had not obtained a sun screen rating on the product. Some of the brokers on the west coast were promoting the liquid baby powder as being safer than conventional baby powder. Baby powder was frequently inhaled during diapering which was suggested by some authorities to be a potential health hazard for infants.

One of the shortcomings of the product line was that the powder tended to separate from the liquid and settle to the bottom of the bottle. This was easily corrected by shaking the bottle vigorously before applying to the skin. Alternatively, a chemical could be added to some of the products to prevent separation, but this additive would rob the product of its 100% natural product status.

The Skin Care Industry

Statistics Canada information obtained by James Gorman was limited to figures on Average Annual Family Expenditures for Face Creams and Lotions. The 1988 figures revealed that the average Canadian family spent $24 per year for face creams and lotions. The low figure was $16 per family in Atlantic Canada1 and the high figure was $37 in Alberta. Ontario and Quebec were closest to the national average.

1 Atlantic Canada includes the provinces of New Brunswick, Nova Scotia, Prince Edward Island, and Newfoundland. The total number of families in 1988 was approximately 560,000.

Industry sources indicated that almost all categories of personal care items, i.e., shampoo, perfume, toothpaste, deodorant, etc, were showing growth, but skin care products were considered the fastest growing category. Some industry people estimated that the skin care market in units had grown by 30% in the eighties. In 1988, the total market in Canada for creams and lotions was approximately $162 million. Atlantic Canada accounted for approximately $9 million of this total and Ontario accounted for approximately $63 million.

Skin care products were available to consumers through drug stores, boutiques, discount stores, department stores, food stores, as well as network sales organisations such as Avon and Mary Kay. A partial list of skin care products included moisturisers, skin food, cleansers, cold creams, astringents, toners, hand creams, hand lotions, medicated creams, baby lotions and depilatories.

There were hundreds of consumer goods companies which had skin care product offerings that ranged in price from $2.99 for 400 ml to $10.99 for 200 ml. The acknowledged volume leader was Cheseborough-Ponds Vaseline Intensive Care. This product occupied the low price general-purpose segments of the skin care market. Oil of Olay was another popular skin care product which occupied a higher priced cosmetics segment of the market.

James Gorman was told that many new products from both new and established companies were competing to get on retail shelves. All products were backed by extensive consumer marketing programs, but some were successful while others were withdrawn from the market after a short time. According to retailers, the market was highly fragmented because of the large number of brands and prices. No manufacturer could claim a share greater than 15% overall and no brand dominated the market. Recent market growth suggested that more new brands would soon be offered to the market.

Shoppers Drug Mart

In the course of investigating the market potential, James Gorman met with buyers representing Shoppers Drug Mart Atlantic region stores. They expressed interest in the product and agreed to promote it in their 106 stores throughout Atlantic Canada, provided the product was supported by a consumer promotion.

This was an exciting opportunity for James Gorman since Shoppers Drug Mart represented approximately 45% of all drug stores in the region. He believed a successful launch would open doors nationally and spark interest among other chains in Atlantic Canada. The second largest drugstore chain in Atlantic Canada was Lawtons, which included an estimated 80 stores.

The Shoppers Drug Mart proposal involved a three-month exclusive deal starting in April of 1989. Shoppers suggested that a television advertising campaign was necessary to establish the product. The cost was estimated to be $50,000. This included the cost of producing a thirty-second television advertisement (videotape) and the purchase of media time.

Shoppers also suggested producing a 50 ml sample size container which would be offered in addition to the standard 250 ml size. This sample size would sell at retail for less than one dollar and would return the standard 40% margin to the retailer. Most of the other national brands of skin care products offered a sample size of their product.

Shoppers indicated that their initial order would be for 1,800 cases (approximately a 90 day inventory). If the product was discontinued or unsold at the end of the period, then the product was to be purchased back from Shoppers.

Shoppers was not able to guarantee that all their stores would purchase the product. The final buying decision for any product remained with each store owner. They agreed, however, to promote the product to each store through internal communication.

Each month, Shoppers produced a flyer that was delivered to all households in Atlantic Canada. They promised to feature the Peruna line at least once during the launch period. The flyer represented an additional cost of $1,500.

James Gorman believed that Shoppers' proposal was one sided because he seemed to be taking all the risk. Nonetheless, he was aware of how difficult it was to get shelf space for a new product. James Gorman decided to involve Peruna International in the venture and to investigate the possibility of obtaining government assistance.

Partnerships

James Gorman informed Peruna of the opportunity with Shoppers Drug Mart. Peruna was interested because the initial order alone represented more than half of the $100,000 in sales that they had achieved in three years. They also realised that if the venture was successful, James Gorman was more likely to purchase the licence to produce and market the product.

They agreed to provide the product for the initial order and the guarantee to purchase back any unsold product if the launch was unsuccessful. They also agreed to package the sample size product which was requested by Shoppers Drug Mart, although they did not currently produce a sample size. James Gorman calculated that transportation and tariffs would be approximately $1 per case.

James Gorman also contacted potential brokers who could service the Shoppers outlets and discovered that they would charge a fee of 10% of the wholesale cost. (See Exhibit 2 for a schedule of wholesale costs delivered to Atlantic Canada.)

James Gorman approached the Atlantic Canada Opportunities Agency (ACOA) to determine if any government assistance was available for the project. ACOA was a federally funded government agency which provided financial assistance to help establish new businesses in Atlantic Canada. (See Exhibit 3 for more information on ACOA programs.)

ACOA officials indicated that the production and marketing of Peruna products in Atlantic Canada was eligible for support. ACOA indicated that support for the project, which could include assistance with capital facilities and purchase of a licence from Peruna International, was contingent on the project being feasible. The first step in this process was to conduct a market assessment for the Peruna product line. ACOA was prepared to cost share up to 50% of the assessment cost.

James Gorman arranged for a market assessment to be conducted in the winter of 1989 at a cost of $20,000. The study concluded that a test market through Shoppers Drug Mart outlets should be conducted with ACOA assistance prior to making any commitment to acquiring a licence and building a manufacturing facility. ACOA agreed to cost share a television advertisement and media time up to $25,000. They refused to share any cost associated with transportation tariffs, brokerage fees or other selling costs.

James Gorman had been advised that a salesperson should visit outlets during the test market. The salesperson was considered necessary because the broker's coverage of the market was not extensive nor did it focus on Peruna products. Peruna International was prepared to provide its recently hired salesperson for approximately six weeks, but James Gorman was expected to cover salary and travel at an estimated cost of $7,000.

Conclusion

James Gorman was becoming frustrated with the Peruna venture. He remained enthusiastic about the prospects for the Peruna line, but he recalled that his current business had been established in a few short months with a small investment and a lot less study and review. The issue was becoming more complicated than just the test market. It had become apparent that a small share of the Atlantic Canada skin care market was not going to sustain a manufacturing facility. James Gorman had been advised that success in Atlantic Canada would be followed by a "rollout" into other markets in the United States and Canada. However, the up-front marketing costs for this type of development were conservatively estimated at $500,000.

James Gorman wondered if he should proceed with the test market or simply drop the whole project and concentrate on his existing business.


Exhibit 1

Sample of Promotion Material Sent to
US Brokers by Peruna International

Natural Itch-Soothing Cream

Stops the "itchy feeling"
Long lasting relief from rashes, Poison Oak (Ivy), insect bites and
other irritants
Checks itching from measles and chicken pox

Peruna Natural Liquid Foot Powder

Apply as a lotion, dries to a powder
Contains Goldenseal, nature's antibiotic
Inhibits growth of fungi causing Athlete's Foot
Originally developed for athletes, now used by all
Controls chafing, odour and itch
Absolutely no inhalation dangers such as with talc or cornstarch powders

Peruna Natural Velvet Creme Hand Lotion

Unique and revolutionary dry formula
Natural and expensive ingredients
Smooths and immediately aids in healing rough, dry skin
No wet, greasy feeling
Brings that long, lasting "Touch of Velvet"

Peruna Natural Body Powder

Natural liquid body powder is a soothing lotion that revitalizes and conditions skin after bath or shower
On like a lotion, dries to an absorbent powder
Controls chafing, odour while soothing areas of friction
Excellent for prosthetics, orthotics and bed sores
Absolutely no inhalation dangers

Peruna Natural Liquid Baby Powder

Apply as a lotion dries to an absorbent powder
No inhalation problems for baby or mother
No messes to dean
Aids immediately in starting the healing process of baby's rashes
Works with the skin to help heal itself

Source: Peruna International

Exhibit 2

Price List for Peruna Product Line
Wholesaler to Broker1

50+ 200+ 500+
Cases Cases Cases
Product2
Itch Soothing 38.48 36.83 35.18
Foot Powder 38.48 36.83 35.18
Hand Lotion 38.48 36.83 35.18
Body Lotion 34-21 32.56 30.91
Baby Powder 34.21 32.56 30.91
1 Canadian Dollars (1988)
2 Each case contains 12 18oz/250 ml containers

Source: Peruna International

Exhibit 3

Atlantic Canada Opportunities Agency Action Program

The Atlantic Canada Opportunities Agency (ACOA) is a federal government development agency with a distinct difference - it's all for Atlantic Canada. Created specifically for the region, ACOA is based on consultations with people throughout the region. We're looking for entrepreneurs and making it easier for them to get action, by cutting the red tape usually associated with government assistance. ACOA knows that when you've got a good idea, you can't wait to get going.

ACOA's mandate is to promote the long term economic growth of Atlantic Canada. That means working to make improvements over the long haul, not just going for a quick fix. An important step is to create and implement development programs for small and medium-sized businesses.

Some Areas of Assistance Under Action Program1

Loan Insurance - When you can't get adequate funding from a financial institution on your own, the ACOA Action Program may provide loan insurance for new capital investments to help you get started or get growing. New term loans of $100,000 or more normally qualify for 85% insurance for a maximum of 15 years. Lenders are charged a yearly fee of 1% of the insured amount.

Interest Buy Downs - The ACOA Action Program may compensate you for part of the interest payable on new terms loans for new capital investments of $25,000 of more. For example, your bank might charge you 13% interest on your loan. With ACOA Action Program Assistance, you could recieve a contribution reducing that to as low as 7% interest.

Studies - Thorough analysis and study are the keys to economic success. If your commercial operation is eligible for capital contributions or Innovation Assistance (see below), the ACOA Action Program may also help you contract qualified consultants to initiate business or marketing plans, perform market research, undertake a venture capital search or technology transfer search, implement a feasibility study or investigate licensing opportunities for newly developed products and services.

New Facility Establishment - A contribution may be offered for up to 50% of the capital costs of establishing a new facility Under limited circumstances, this can include purchasing the assets of an existing facility but not mergers, acquisitions of a company or refinancing current assets.

1 Does not include all of the ACOA programs

Source: Atlantic Canada Opportunities Agency