The stitch house: a case of entrepreneurial failure.

Kampschroeder, Karl F. ; Ludwig, Nancy ; Murray, Mary Ann 等

CASE DESCRIPTION

This case concerns why entrepreneurs fail. Issues related to the case include how entrepreneurs make decisions, the marketing, financial, and accounting issues that should be considered when starting a new business. A secondary issue illustrated by the case is the risks involved in mixing business and personal finances in a start-up business. This case has a difficulty level of three. However, it may be used, with time allowed to develop alternate scenarios of the business owner's choices, in both senior and first-year graduate courses. The case is designed to be taught in one 75-90 minute class session and is expected to require one to two hours of outside preparation. Alternatively, an instructor may elect to use this case to challenge advanced students to create a business plan that would have a greater likelihood of success. For such use, the case may require up to 5-6 hours of outside preparation. Additionally, a shortened version of this case has been used effectively as an examination case in a senior-level Entrepreneurship course.

CASE SYNOPSIS

Why did The Stitch House fail so quickly? Louise had business experience, adequate start-up capital, and people with experience in marketing her product. But, in less than six months time what seemed like a certain success consumed her capital, was abandoned by her erstwhile partners, and left her with substantial personal debt. This case gives students the opportunity to learn from one of the majority of new small business start ups--those which fail in less than two years. Based on an actual entrepreneurial situation, the case illustrates the impact that each decision an entrepreneur makes may have on the ultimate survival of the business and how easily a new business can fail. It presents students with the opportunity to analyze the basic decisions that an entrepreneur must make in creating a new business. Alternatively, advanced students may be challenged to re-construct the business concept and create a business plan for The Stitch House.

INTRODUCTION

"What am I going to do now," Louise thought to herself. "Oh well, if we can't make this work out maybe I can get something out of it on Ebay." The "It" Louise was looking at was a 15needle, single-head commercial embroidery machine, the kind used to stitch designs on fabric--company logos on polo shirts for example. "It" and the office equipment stored in her garage were was the only things remaining from Louise's venture into her own business; she still owed several thousand dollars on the purchases.

THE ENTREPRENEURIAL URGE

Louise wanted to start her own business. In Fall, 2004, newly divorced and holding a reasonable financial settlement, Louise moved back to San Antonio, Texas, where most of her family lived. After ten years in California, she was ready to restart her life. Thinking over her options, Louise decided that, with the cash she had from the settlement, now was the time to do it--to go into business for herself. After all, she had worked with her now ex-husband in his furniture business for over 5 years and knew how a small business operated--and she liked the idea of being her own boss.

As luck would have it, about three weeks after moving to San Antonio, Louise met Robert and his friend, Luis, at a social event at her cousin's house. Both Robert and Luis were in the commercial embroidery business and both were unhappy with their present employer. Most importantly, Robert had many contacts in the business and was sure that there were opportunities in the area, in some aspect of the commercial embroidery business. Economic conditions in San Antonio and the South Texas region were better than they had been in years. The two men seemed to have all the skills needed to get started: Robert sold embroidery products--so he had an established clientele--and Luis worked in the operations side of the business--so he understood the production process. Robert suggested to Louise that the three of them should go into the embroidery business.

On her way home from the party, Louise started feeling a little uneasy about entering into business with total strangers. She realized that she knew very little about them, although she assumed they were "OK" since she had met them at her cousin's house, and she trusted her cousin. Still, she thought she had better find out a little bit more about why they were so eager to start a new business. She decided to call Robert and Luis over for an informal get-together at her house, supposedly to discuss the business, but more importantly to get to know them better and determine their motivation for entering into this venture.

What she found out was that both of her prospective partners had problems and both wanted to make money as quickly as possible. Robert had a disagreement with his current boss over his 'selling practices', and expected to be fired soon. Instead, he had decided to 'quit at the first opportunity', and 'take away' his client base with him. This new venture seemed a good opportunity to be his own boss, and get rich at the same time. Louise also noted that he had two grown sons, and he was paying for their college education.

Luis on other hand seemed much less interested in making money although, having recently been divorced, he certainly needed it. He seemed like a very shy individual as well--she was not able to get much out of him until he had had a few drinks. She found out that he was 'bored' with his current job and was looking for a new 'interest', as he put it. He seemed very excited to talk about the production side of the business--about how to set up production runs, and about how to spool the threads, etc.. but did not seem very excited about the financial side of the business. When asked about it, he said, "You two seem very capable....I will leave it in your hands." Luis spent a lot of spare time in the local bar watching sports and drinking 'with the boys.' Oh well, she decided, they weren't perfect, but they seemed like the best chance she'd get to start her own business with experienced people. After this conversation and subsequent conversations over several days, Louise agreed to form the venture. She thought Robert and Luis were a good match with her administrative and bookkeeping experience from her ex-husband's furniture business.

Louise set up her business, Louise--d.b.a The Stitch House, as a sole proprietorship. She then wrote a contract specifying that all three participants--Robert, Luis, and she--would share in the profits as partners. Thus, salary expenses could be at a minimum but all would be committed to the success of the enterprise. Initially, Robert's idea was that they would be in the business of supplying thread bobbins (bobbins loaded with thread for the embroidery machines) to commercial embroidery shops in San Antonio and the South Texas region. However, due to the need to invest in a large inventory to start a bobbin supply business, the three partners decided this was not feasible. Based on Robert's recommendation, they then decided that their success would lie in being in the commercial embroidery business--not in being suppliers to it. The role that each was to play in the business matched their perceived expertise: Robert was responsible for sales, Luis would operate the equipment to produce the embroidered products, and Louise would manage bookkeeping, and order processing and fulfillment. Louise supplied all of the working capital. Still, nothing about the responsibilities and authority of each partner was specified in the contract, but Louise thought she knew enough about Robert and Luis to start the business--and The Stitch House was born.

THE INDUSTRY

The commercial embroidery business produces a wide range of goods, all of which consist of a fabric product embellished with an embroidered design. Products may range from large quantities of apparel, such as polo shirts or baseball caps with corporate or team logos, to individual items with monograms or personalized designs.

Products sold into the high-volume corporate market are typically catalog items that, for marketing purposes, may be grouped together with other advertising specialty products such as embossed desk accessories, corporate coffee mugs, or other business souvenirs. This segment of the market usually purchases in large quantities (>100-250 pieces) and pricing to it reflects the volume orientation. Typically, the marketing channel is catalogs (both print and online) and manufacturer's representatives. Smaller-volume items and one-of-a-kind items are most often marketed locally or regionally through direct sales at retail outlets or via personal selling, mail-order, or websites. A significant, and highly competitive, segment of the market is for monogrammed goods for local groups, such as sports teams. This segment is supplied most commonly by local embroidery firms who sell in bulk at wholesale prices.

From a production standpoint, the industry may be divided into three types of firms: contractors, wholesalers, and retailers. A 2004 industry survey by Stitches magazine, an industry trade journal reported that respondents classified themselves as follows: 22.8% contractors, 16.6% wholesalers, and 59.7% retail. A simple way to understand this specialization of production is that contractors sell in large quantities through intermediaries. In a 2005 industry survey, the four largest firms in the U.S. each reported embroidering more than 3,000,000 pieces. However, it should be noted that a number of large firms reported that production volume was essentially flat year-on-year. This segment of the industry also faces significant foreign competition.

Wholesalers sell medium-sized lots to group purchasers such as local sports teams and clubs who may re-sell the products (hence the term wholesalers) for fund-raising. Although many wholesalers are small operations with few employees, they typically operate higher-capacity equipment in order to fill bulk orders quickly. Retailers, the segment subsequently entered by Louise and her partners, typically sell single items or small quantities to individuals. Although some may operate out of a mall kiosk, most retailers operate from home. A further indication of the structure of the industry is that, in the 2005 survey, only 18.6% of the 500+ respondents reported having 3 or more employees.

Barriers to entry into the industry are relatively low; an individual may enter the retail segment of the industry with a relatively low investment in production equipment or may enter as a reseller, or representative, selling the production of any small job-shop operation. Additionally, embroidered goods are not a necessity. While embroidered goods may convey the image of higher quality and embroidery has better wear characteristics (lasts longer), embroidery can be replaced by lower cost stenciling or screen-printing in many applications and in fact, many embroiderers also sell screen printed merchandise. Locally in San Antonio, 60 firms (not including The Stitch House) are listed as embroidery suppliers in the Yellow Pages directory. In summary, the industry is highly fragmented, with competitors of all sizes and a wide range of customer types and sizes (Parsons, 2004, 2005, 2005).

START-UP DECISIONS ARE MADE

After dropping the idea of becoming thread bobbin suppliers, the partners decided to target a specific market segment: the baby industry. While there were many competitors trying to sell embroidered baseball caps to teams, she felt that was a strong potential demand for baby clothes with embroidered designs. Her mother told Louise that everyone liked baby clothes with embroidery--but no grandmothers had the time to do that by hand anymore. And unlike baseball caps--baby clothes get outgrown and have to be replaced often. It seemed like a great opportunity--not only would they make money on the embroidery--they would get a markup on the clothing item also.

Once the decision was made to produce embroidery, Louise also went to work to get the business going. She leased commercial space, got a friend of hers to create a web page for the business, and set about obtaining the necessary equipment. After some research, Louise was given a proposal by the firm that seemed to be the best equipment supplier; a bit concerned about the price, she asked for and was given an alternate proposal. Either option could be acquired via a lease with a fair market value purchase option at the end of the 45 month lease. The lease would be through a commercial leasing company that frequently worked with the equipment company. The two equipment choices and their costs are shown in the table below. Louise wanted to do this right--so she decided not to consider looking for used or re-conditioned equipment. They couldn't afford equipment that might break down when they needed to produce a big order. But at the same time, she was concerned about costs; Louise decided to lease the single-head embroidery machine. However, before she made the phone call to lease the machine, she wondered if she should solicit the advice of the other two partners in this decision. She decided, she had made all the important decisions so far anyway--she was the boss, wasn't she? With a deep sigh, she placed the lease order for the machine.

READY FOR BUSINESS--BUT ...

By late January they were ready to go. The equipment was in place, the website was up, and Luis was ready to start production. There was only one problem: orders were coming much slower that Louise had expected. Robert complained that it took much too long to make product with the single-head machine that Louise had leased. So, or at least he said, he couldn't go after the really big orders he needed to make real money. After four weeks, he abruptly quit. With what she had already invested in the business--over $20,000 at this point--Louise decided that she couldn't quit now. She'd helped her ex-husband sell furniture, now she'd sell baby blankets, or caps, or whatever embroidered products she could sell to the many independent baby and clothing stores around San Antonio. Then she remembered--Luis--where was he? He did not answer his cell phone but Louise knew she could always find him at the sports bar. But she decided that he was next to useless when important decisions had to be made. So, she decided that she could 'go it alone' if need be.

However, orders proved extremely hard to come by. She couldn't even get a special order for ball caps from her cousins Little League team--they'd made the playoffs and wanted 60 special caps made in four days. While Luis said they could do it, they'd have to charge $1.00/cap more than another supplier and then they'd just cover their costs.

SHUT DOWN OR RE-START?

By April, Louise was ready to quit. Total revenues since startup were still less than $1,000. As the charges on her credit cards mounted she gave up the commercial space and moved the embroidery machine into her garage. A family member told her about an acquaintance of theirs who was working on an MBA degree at a local university--maybe she would have some ideas that could help Louise get the business back on track. After talking on the phone to the student several times, Louise was optimistic. This kid sounded pretty bright. She'd asked Louise to put together some information for their first meeting. After going through the reports she had from her accountant and remembering some of the things that had occurred, Louise wrote out the following on a legal pad:

1. with pattern, takes about 20 minutes to set up machine to stitch, takes about 5 minutes to stitch one blanket;

2. good blankets cost $4.00 wholesale, selling price after embroidery is $10.00 to a store;

3. use the same markup for caps and sweaters, they sell to stores for $4 and $10;

4. my costs:

A) rent + security service $1200/month (stopped)
B) advertising & website $600/month
C) equipment lease $485/month
D) general office expense $200/month
E) payoff Visa balance $350/month (balance is $7800)
F) Luis $minimum wage + profit share

She sat back--looked at this way the numbers didn't look so bad. Yes she'd spent a lot of money getting started; in retrospect she should not have bought all new office furniture and equipment. But without the rent payment she ought to be able to make a success of this yet, she'd just have to get selling--and get used to having Luis working in her garage. But actually he was sort of cute, so maybe this would all work out after all ...

REFERENCES

Parsons, Ken (2004). 2004 Industry Survey. Stitches Magazine October 1, 2004. Retrieved February 12, 2006 from http://stitches.com/mag/apparel_industry_survey/index.html

Parsons, Ken (2005). Embroidery Industry Demographics 2005. Stitches Magazine March 1, 2005. Retrieved February 12, 2005 from http://preview.stitches.com/demographic.pdf

Parsons, Ken (20005) Top 15 Shops of 2005. Stitches Magazine July 1, 2005. Retrieved February 12, 2006 from http://preview.stitches.com/top%20shop-705.pdf

Karl F. Kampschroeder, St. Edward's University

Nancy Ludwig, Valero Energy Corporation

Mary Ann Murray, St. Mary's University

Prasad Padmanabhan, St. Mary's University

Table 1: Stitching Machines

 15 needle--6 head * 15 needle--1 head

Purchase price $46,690.00 $19,990.00
Installation $1,295.00 $995.00
Due at lease signing $9,098.00 $3,824.00
Monthly lease payment $1,144.00 $487.00

* number heads determine the number of pieces that can be worked at
one time, a 6-head machine can work 6 pieces a 1-head machine can work
one piece.