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Case Analysis Point Allocation Steven Belkin

Do all the sections in the Case Analysis Point Allocation.

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Harvard Business School 9-383-042 Rev. September 13, 1988

Senior Research Associate Richard O. on Werssowetz, prepared this case in association with Professor Howard H. Stevenson as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 1982 by the President and Fellows of Harvard College. To order copies, call (617) 495-6117 or write the Publishing Division, Harvard Business School, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Harvard Business School.


Steven B. Belkin Wake up, Steven! It must be some mistake, but American Express is calling

and says it's important. It's something about your credit rating.

His wife's voice roused Steven Belkin from a fitful sleep. A cascade of problems swept through his mind as Joan handed him the telephone:

This must be about my $15,000 overdue credit card bill. Joan hasn't realized I'm in quite so deep. . .she's going to be a bit shaken by this. I can see I'd better reassure her when I get off the phone. . .but to tell the truth, if I don't find investors soon, I'm really in trouble.

It was 11:30 the night of December 5, 1973. Steven Belkin had charged many of his expenses while trying to set-up a new group travel business. Finding investors was proving much more difficult than he had anticipated and he had had to let his bill slip for a couple of months. Steven was going to have to find a new financing strategy fast to keep The Travel Group from being a one-way ticket to disaster.


Steven Belkin, age 26, had lived in Grand Rapids, Michigan as a youth. There he had his earliest business experiences. When he was 12, his grandfather had given him some salvaged automatic letter openers. Steven decided to set up a raffle, with $1 tickets and the letter openers as the prize. He enjoyed selling the tickets and felt wonderful telling the purchasers who had won. Another time he sold light bulbs door-to-door. Taking the idea from a school fund-raising project, he made it a summer job for his own profit. Steven's parents were of modest means and financial pressures were a source of family discord. Steven resolved that his own excellence and success would provide family happiness.

Several people advised Steven that the way to success was to couple engineering with business school. After graduating from high school where he had been captain of his basketball and tennis teams, Steven received an industrial engineering degree from Cornell. He concentrated on obtaining good grades at Cornell and also was active in student government and other school

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383-042 Steven B. Belkin


activities to improve his chances for admittance to graduate school. After graduation in 1969, Steven entered the MBA program at Harvard. Steven recalled an interview he had set up:

I tried to figure out how best to improve my odds to get in. I came down and had an interview and talked to different people. I don't know if it helped—they say it doesn't, but I don't know. I always took the attitude to absolutely give everything you have. Then if you don't make it, at least you have given all you've got.

Steven saw life as a series of plateaus. At Cornell, grades had been important to reach the next level. Having reached business school, Steven now wanted to concentrate on learning about different kinds of business and on getting to know his classmates. Steven recalled:

I felt I needed to get there faster than the usual course. It wasn't okay for me to get there in the regular process, riding someone else's wave. I needed to get ready to jump on my own wave. In order to do that, to speed up the process, I needed to have more experience and contacts than my years. You get that extra knowledge from the experiences of others. And the families and friends of your classmates are a wealth of contacts.

Steven and another student obtained the resume concession at HBS which not only helped with expenses, but also gave him a chance to meet all members of his class.

Innovative Management

During the summer between the first and second years of the MBA program, Steven decided he wanted to do consulting for small businesses. He asked friends and professors for leads, with little success. However, he did find that four graduating students were starting a new consulting company in that area which they would name Innovative Management (IM). Actually, one student had some possible business sources and had found a financial backer who would provide $50,000 for working capital. That student had asked the others to join for a salary and 5% portions of equity. Steven joined in the same fashion and the group quickly got underway. Steven described their start-up:

We would go to bankers and individual venture capitalists who had made loans or investments in companies that weren't doing as well as they had hoped. We offered to go in and analyze the situation and either suggest that they write off the situation or propose a plan to improve the company. Then we would actually go in and implement our suggestions.

The bankers and private investors we approached often didn't have the time or the ability to do this type of analysis. So they would go to the head of a company in trouble and point out that things weren't going very well, then suggest that the company employ us for the study as a condition of providing more funds. The companies would pay our fees which usually were $4,000 to $5,000.

Initially, we would approach a new source of projects and offer to do the first job at no cost. After we showed what we could do, they would usually give us additional assignments.

Our customers were companies with annual sales from $2 million to $10 million. Most were fairly new entities. Usually we could provide a needed control system, a marketing strategy—an entire business plan. Although the owners usually were under considerable pressure to let us in, they often were very stimulated by what we did. They knew they had problems and they didn't have the luxury of our

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Steven B. Belkin 383-042


education. After we gave our report to the financial backer, we also gave it to the company. Often we could provide our recommendations in only three or four days.

By the end of the summer, we were so successful that we began hiring additional Business School graduates. I continued to manage several others during my second year of school.

In addition to running the resume service and continuing his consulting business, Steven did a survey of interest in small business among students in the top ten business schools as his second- year project.

My purpose was to show that there was a strong interest in new ventures and starting your own company among these students even though most schools were not teaching that. The survey confirmed this and I used the data to write some articles that we used to publicize our consulting firm. For example, we had stories in the Boston Globe and the SBANE [Small Business Association of New England] paper.

People are always fascinated about people who do surveys and who have statistics. It makes you an instant expert to have a survey! It bought us new contacts and more credibility.

Looking back, Steven commented that he had done too much during the second year:

I was incredibly busy. I cut a lot of classes. But the income was tempting and I was just ready to get the second year over with. But you are always going to have work, yet you only have the second year of business school once. I missed an awful lot. I didn't realize then that the cases contained so much practical experience—I felt they were "text-booky." I just didn't absorb that they really reflected day-today problems.

During the last half of the second year, Steven explored the job market, interviewing primarily with consulting firms. Although none of the firms caught his fancy, Steven thought the process was worthwhile:

It was a terrific educational experience to be able to talk to these high-caliber people in the different companies where they were trying to sell you and tell you all about their companies. But I guess I was a bit spoiled after already having my teeth in it, giving suggestions to people and seeing them implement them the next week. The big companies seemed a little academic—nothing really compared to what I was doing.

Steven remained with Innovative Management when he graduated in June 1971. A year later, however, the company was sold and Steven decided to leave. Steven explained:

We grew from five people to 22 in that first two years. Then one of the individual venture capitalists who had given us some work wanted to buy the company. The other four founders wanted to sell, but I thought that we would lose our objectivity as an affiliated consultant. I wasn't very happy about it, so I left the firm.

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383-042 Steven B. Belkin


Group Touring Associates

Having decided to leave Innovative Management, Steven Belkin reviewed his situation. Financially, he had limited resources. Steven had been earning almost twice the $12,000 typical starting salary of his class. Joan, whom he had married just after graduation, worked as a teacher for a smaller salary. Steven had received $15,000 for his interest in the consulting company but also still owed several school loans that were not yet due for payment. Their net worth was about $10,000. Steven had no special ideas for starting a different business and was not attracted to seeking a job with a larger company. It appeared to him that he should continue small business consulting on his own.

The sale of IM took place at the end of the summer of 1972. Before Steven embarked on an independent course, however, he was approached by Frank Rodgers, the original investor in Innovative Management. Rodgers had been squeezed out of that investment when the company was sold. Rodgers said he would like Steven to work for him helping other companies in which Rodgers had investments and Steven agreed.

Steven found he had a special attraction for a group travel company that was one of Rodgers' first assignments. This company, Group Touring Associates (GTA), developed tours which were sold to various groups by mail using their membership lists. GTA had been started by Robert Goode in 1966 with the backing of Rodgers and a few other private investors. Rodgers had invested $200,000 to date, the others, another $200,000.

Sales had grown to $1.8 million the past year, but GTA had yet to make a profit. Losses had been increasing from $50,000 in 1968 to over $250,000 in 1972, the most recent year. Robert Goode had convinced his investors to continue their backing by pointing to the rising sales. He contended that the front-end marketing costs of mailings and of setting up the trips would cause him to show losses as he grew. On the other hand, the unearned customer deposits made prior to the trips provided much of the cash needed for the growing operation. Rodgers agreed that some losses might have been necessary as the company got its start, but now was alarmed by the continuing deficits. Rodgers felt that the deposit cash flow was disguising more fundamental problems and wanted Steven to help the situation.

After a brief analysis of the business, Steven felt GTA had excellent potential and that it could be built profitably with better management. He accepted an offer to join the company and became GTA's executive vice president:

Looking back at my other consulting clients, there wasn't one business that I wanted to do. I had done one project for another tour operator, but they marketed through travel agents and student groups. The combination of group travel with direct mail made this very fascinating to me—this was the business for me. Okay; I needed solid experience in this one. This was a good opportunity and I could earn a piece of the action.

A year later, Steven could point with price to sales which had grown 50% and to a profit of over $150,000. Steven credited the turnaround to basic planning and well-managed execution:

There was little organization when I came: no business plan, budgets, or anything like that. What I did was to clearly define our product and focus our operational and selling efforts. All within a budget and a plan. Before, the salespeople would try to find what trips various groups might be thinking about and come back and try to put one together. I introduced the strategy of defining the trips

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Steven B. Belkin 383-042


with the greatest general demand, then putting the trips together and having the salespeople fill them up.

This strategy let us buy better, put together better promotional material, and better control our costs. I was very sensitive to the fact that we were in the direct mail business rather than just the group travel business. We had to provide better value for the travel dollar and promote it well by mail.

At the end of his first year as executive vice president, Steven reopened discussion about his future role in GTA with Robert Goode. He had initially accepted a salary of $22,000 with the understanding that they would renegotiate his position after Steven had proven himself. Now Steven felt he should receive a $30,000 salary and also be given 10% of the company. Robert would not agree. Steven recalled:

Robert and I went back and forth quite a bit. GTA was finally making money and I felt I deserved part ownership. Robert wouldn't go over $25,000 in salary and wanted to wait another year for the equity.

As we reached an impasse, Frank Rodgers arranged several more meetings between us. However, now that the company was profitable, Goode no longer needed more equity and Rodgers didn't have enough power to force Goode to agree to my demands. I think Robert also felt that he had run the company for six years and, now that I had gotten GTA over the hurdle, he wanted to be the boss again.

I tried very hard to reach an agreement; I wanted to stay. I felt that if I could be earning the $30,000 and have 10% of a profitable, growing company, I would be on my way to being successful. I was really running the show; I felt I was going to make money; I was fulfilling my entrepreneurial goals.

Considering An Independent Course

As Robert Goode's position hardened, Steven began to consider leaving GTA to start his own group travel packager. Looking at the industry structure made him feel this segment was a good opportunity. Potential air travelers could arrange pleasure trips directly on their own, choose ground packages offered by "tour wholesalers" such as American Express, or select complete air/ground packages such as those organized by GTA using chartered airlines. Traits of these choices are shown on the next page.

Although the group air charter industry had only developed over the last ten years after the introduction of jet air service, this mode of touring had already become a popular travel alternative. Steven felt the key attractions were lower cost, professional tour management, and the comfort and peace of mind of the sponsoring organizations' endorsements.

The lower costs were the direct result of the use of chartered aircraft—the group tour organizer guaranteed to pay for all seats and took the risk of filling the flight. Many travelers were willing to accept the fixed schedules of charters to take advantage of the lower prices. The offer of complete tour packages with professional tour guides was convenient, especially for travelers unfamiliar with the desired destination. Also, each traveler was a member of a group which sponsored the tour and could feel that his or her own representative would make sure the tour was a good trip and that the group would receive everything for which they had paid. This was particularly

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383-042 Steven B. Belkin


important in 1973 because there had been some recent publicity about tours which had been stranded or given inferior accommodations or service.

Table 1 Comparison of Pleasure Travel Options

Direct Selection By Traveler

Use of "Tour Wholesaler" Charter Tours

Air Travel Via scheduled airline. Via scheduled airline Charter

Land Arrangements Individual plans and arranges directly with provider or thru retail travel agents.

Provided by tour wholesaler.

Provided by group travel wholesaler.

Flexibility Complete. Travel timing flexible. Only selected destinations and accommodations.

Fixed departure and return schedules. Only selected destinations and accommodations.

Usual Cost Highest price. Sold as service; cost often same as direct.

30% to 40% lower.

Sold By Individual carriers, hotels, etc.; retail travel agents.

Retail travel agents. Group-sponsored direct mail, some retail travel agents.

Other Limitations Must be member of "affinity group."

Steven saw these advantages as clear distinctions between group charter companies and tour wholesalers that used scheduled air carriers. The tour wholesalers also marketed primarily through retail travel agents whereas charters tours were normally sold using direct mail.

Looking at competition, Steven knew there were ten major group tour operators in the United States. GTA ranked about seventh in that list. Where GTA provided tours for about 8,000 people per year, the largest U.S. operators moved about 50,000 customers yearly. As he viewed the market, he felt there was certainly room for one more:

In the U.S., there were regulations that you had to belong to an organization to go on a group trip. These had been eliminated about six years ago in Europe. With that, some of the group tour operators did more business than some of the scheduled carriers. The largest European companies running group charters were moving over a million people per year each. These regulations were relaxing in the U.S., so I felt there would be great opportunities.

Steven received encouragement from Alan Lewis, GTA's most productive salesman. During Steven's negotiations with Robert Goode, Steven had described his growing frustration to Lewis. When Steven mentioned that he would be happy for Alan to join him if he left, Alan suggested that Steven should go out on his own whether or not Goode agreed to his demands. Alan would like to join him and was anxious to get an ownership position himself.

Steven's discussions with Goode made no further progress, so Steven resigned and left in early September 1973. Alan Lewis also resigned and the two of them began to develop The Travel Group, their own group travel business.

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Steven B. Belkin 383-042


The Travel Group

Steven's idea for The Travel Group (TTG) was to duplicate the strategy that had been successful for Group Touring Associates. They would start with limited tour offerings to the most popular destinations, then expand as their reputation grew. They would use five sales representatives to call on groups across the United States to develop sponsors for direct mail promotions. They would carefully control their customer service and tour operations to minimize costs and gain customer satisfaction.

The tours they would offer were complex logistical tasks with large financial commitments. Running a tour meant chartering an entire plane which would accommodate up to 200 passengers. The company would also have to commit to blocks of hotel rooms and meals and provide ground transportation and other assorted support services. Once the package was planned, promotional material had to be written, printed, and distributed. Then inquiries had to be answered and reservations made.

To run the company, Steven would be president and major shareholder. He would be responsible for raising the capital they would need, for negotiating the trip arrangements, and for setting up the internal operations. Alan Lewis would be executive vice president. He would hire and manage the sales force, cover key clients personally, and work with sponsoring groups to fill the tours. Steven described their deal:

I had planned to give five key salespeople 5% of the company each. Alan convinced me to give him the entire 25% and he would give away whatever was necessary to hire the others. Thus we became partners, but I would have a minimum of 51% ownership, Alan up to 25%, and the remainder would be for me or the investors. He ended up keeping all 25% after hiring four other excellent salespeople. Equity for our financial backers would come out of my share.

Steven and Alan immediately swung into action. Steven concentrated first on creating a business plan, while Alan began his search for salespeople and selling efforts for an initial tour he and Steven had outlined. By October 1, 1973 the business plan was finished and Steven prepared to raise $250,000:

Developing the plan was fairly straightforward. We knew the basic charter travel destinations and seasons. We planned to run one airplane a week in season during the first year, two places a week the second, and build each year. It was important to run "back to back" tours as much as possible so that the chartered plane could take one tour and return with the prior weeks's group. I added cost projections and made cash flow assumptions to give an overall financial plan.

The plan showed an accumulated deficit of $155,000 for the five months before our first tour. Then I expected profits and tour deposits to provide cash for growth. I felt I should raise $250,000 for a sale cushion to fund that deficit with room for unexpected costs, delays, or errors.

The business plan for The Travel Group is shown in Exhibit 1. Steven intended this document to be a simple, easy to follow business plan rather than a formal investment memorandum. He explained his reasoning:

Most people make business plans so complicated that people understand nothing and get scared by them. If you repeat things two or three times, then they

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383-042 Steven B. Belkin


say, "Oh, yes. I understand that." They think they understand what they are investing in. If you keep giving them more and more inputs and ideas, they just can't absorb it.

When people finish reading my simple description, they understand what I have said. That does not mean they understand the business. But hey have understood what I said, so therefore they think they understand the business.

Financing Strategy

Steven and Alan had direct experience in the operational tasks confronting them. Finding the needed financing was less familiar. However, several of Steven's earlier IM consulting assignments had involved raising money for smaller companies. Steven described IM's role:

Some situations we investigated needed more equity along with the strategic and management changes we might suggest. If asked to implement our plan, we would agree to raise the money along with providing an executive vice president to bolster management and increase the company's credibility to investors. In return, we would receive part of the equity.

We tried to keep this from being threatening to the president. Rather, we worked to convince the president that we'd be adding some new skills and helping to make the company valuable. Not like we were after the president's job.

We'd approach individual venture capitalists for investments of $25,000 to $50,000 each. Our total needs were usually $100,000 to $200,000. The Rodgers family was very well connected and we had developed other contacts in the course of our projects.

Pricing was rather arbitrary. The company probably didn't have earnings and we were selling the future. There was no scientific approach. We tried to show that the investors would double their money in a three year period, then double it again to a value four times their original investment by the end of year five.

Structurally, these investments sometimes ended up as a combination of debt and equity. This might be a loan with stock warrants. If all went well, they'd get most of their money back in a year or so and keep an equity ride with the warrants. The investors were very interested in not losing—not making mistakes, and less worried about how to get their equity out. That was less well structured—something down the road.

With this limited fund-raising experience, Steven developed a financing strategy. First, he assessed the situation from an investor's point of view. TTG had a large upside. Few start-ups could show the rapid sales growth Steven had projected. There were good margins that gave an excellent profit potential and unusually attractive cash flows. The management team had strong credentials. Steven's education was a plus and both he and Alan had been successful running a similar company. They would also be using an experienced sales force. The group travel market in the United States had much less penetration than in Europe and should grow rapidly. Finally, there was little sophisticated competition in this industry so their management skills would given them an extra advantage.

To demonstrate long-term potential, Steven could also show evidence that a group tour operator could be attractive as a public stock offering. One large U.S. tour operator had gone public in 1967 at a price of $10 per share. Within two years, the price had risen as high as $93 per share. The

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shares were currently trading for about $8, but this was primarily the result of that company's poor results in diversifying into restaurants, cruise ships, and hotels.

Steven decided that this set of characteristics made TTG a good deal for institutional venture capital groups. He would attempt to raise the $250,000 in five units of $50,000. He hoped that two or three investors would subscribe to the entire total. Steven felt this was a better alternative than going to wealthy individual investors for smaller units:

I thought the larger shots would be easier. I had the right background and credentials and a good business plan. I was sophisticated enough to present it to institutional investors. I felt this was a good package to offer, that they would buy me and would buy the business plan.

As insurance, Steven would also present the plan to a few individual investors, but his main thrust would be the institutional groups.

For leads, Steven turned to the "hit" list he had been developing since he had been in business school:

I kept a notebook of people I met who might be good contacts. I'd put in notes on meetings and phone calls, addresses, correspondence. Some were filed in various institutional categories—others were just alphabetical.

I put the people I would approach in priority by relationships. I wasn't going to ask people directly to invest. Rather, I would ask for their help: "What should I do to raise money?" I didn't want to put them on the defensive—once you ask them if they'd invest they have to protect themselves. This way, they could talk to me totally straight and