GIT Evolution of Zappos Management Discussion

For the exclusive use of K. Hernandez, 2022.
Entrepreneurship
Lynda M. Applegate, Series Editor
+ INTERACTIVE ILLUSTRATIONS
Leading
High-Growth
Ventures
LYNDA M. APPLEGATE
HARVARD BUSINESS SCHOOL
8082 | Published: June 30, 2015
This document is authorized for use only by Korey Hernandez in MGMT 614 Entrepreneurship:Growth Strategies-1 taught by ELIZABETH SIKKENGA, Eastern Michigan University from Jan
2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
Table of Contents
1 Introduction………………………………………………………………………………………………………………………………………….. 3
2 Essential Reading …………………………………………………………………………………………………………………………….. 5
2.1 Transitioning to Growth ……………………………………………………………………………………………………… 5
2.2 Evolving Strategy …………………………………………………………………………………………………………………. 12
2.3 Evolving Capabilities and Organization ………………………………………………………………. 13
2.4 Zappos Evolves Its Capabilities and Organization ………………………………………. 17
2.5 Evolving Leadership, Management, and Governance………………………………… 21
What Do Leaders Do? ……………………………………………………………………………………………………….. 23
Designing Governance Systems for High Growth Businesses……………… 25
2.6 Conclusion …………………………………………………………………………………………………………………………………. 26
3 Supplemental Reading ………………………………………………………………………………………………………………. 26
3.1 A Day in the Life of Two Entrepreneurial Leaders ……………………………………….. 26
Case Example: Leading NerveWire in Turbulent Times …………………………… 27
3.2 Do Managers Matter in 21st-Century High-Growth Businesses? ………… 33
3.3 Strategic Growth Options ………………………………………………………………………………………………. 37
4 Key Terms……………………………………………………………………………………………………………………………………………. 39
5 For Further Reading…………………………………………………………………………………………………………………….. 39
6 Endnotes ………………………………………………………………………………………………………………………………………………. 40
7 Index ……………………………………………………………………………………………………………………………………………………….. 43
This reading contains links to an interactive illustration and online videos, denoted
by the icons above. To access these exercises, you will need a broadband Internet
connection. Verify that your browser meets the minimum technical requirements by
visiting http://hbsp.harvard.edu/list/tech-specs.
Lynda M. Applegate, Sarofim-Rock Professor of Business Administration, Harvard
Business School, developed this Core Reading with the assistance of writer Karen
Propp.
Copyright ? 2015 Harvard Business School Publishing Corporation. All rights reserved.
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2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
1 INTRODUCTION
Entrepreneurship is not really building a product, it?s not having an
idea, it?s not being in the right place at the right time. It?s fundamentally
company building.
?Eric Ries1
L
aunching a venture is exciting and intense. But transitioning a new
venture to growth requires endurance and deliberation. If a launch is a
sprint, growth is a marathon. The strategy and organization must continually
be reevaluated and realigned, leadership depth must be built, and calculated
risks must be taken.2
Once a venture has gained traction in the market and begins to grow, the focus shifts from
?burning cash? to generating positive cash flow. And once cash flow is positive, entrepreneurs
confront new questions: What is the best path to building a sustainable business? Which
approach to growth should we take, and which option best enables us to leverage our current
strategic position, operating platform, and organization? Will we need new internal skills and
expertise and new external partners? How will we finance growth? How will we manage risk?
How will we make decisions when 50 or 100 or even thousands of people, rather than 5 or 10,
must be involved in making them?
In his article ?Evolution and Revolution as Organizations Grow,? Larry Greiner writes that
companies grow through periods of evolution, when change is modest and manageable,
punctuated by periods of revolution, when change is radical.3 The initial period of revolution
for a new venture often comes as it transitions from the early experimentation phase to
growth?growth that generally involves scaling the existing business by penetrating its existing
markets and building the operating capacity to meet growing demand. Scaling requires
leveraging the capabilities that were built to enter the market while building new operating
capabilities as the organization shifts from a multifunctional team to an interconnected set of
functional work units. Scaling may also require new leaders who understand how to manage
the increased organizational and business complexity.
As the business continues to grow, it often enters a second period of revolutionary
change?a shift from scaling the entry business to expanding its scope. During this period,
leaders may decide to enter new markets or launch new products, and strategic complexity
increases. They may even decide to launch new businesses. As the business strategy becomes
broader in scope, new organizational units are often created and organizational complexity
also increases. New leaders are needed to manage new businesses. New leaders may also be
needed to run increasingly complex shared-services organizations. For example, experienced
executives may be hired to staff senior leadership positions, such as chief financial officer,
chief marketing officer, chief information officer, chief operating officer, and chief human
resources officer. These C-level executives often join the CEO to form the executive
committee, which reports to the board of directors. At the middle of the organization,
managers are needed who interface directly with the executive committee and the operating
units to coordinate and control the expanding business.
These two kinds of growth that scale the entry position and increase the scope of the
business strategy and organization allow a business to achieve economies of scale and
economies of scope.
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2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
What Are Economies of Scale and Scope?
Economies of scale are created when a business leverages its current strategic
positioning and/or capabilities to penetrate existing markets with existing products
while also decreasing the average cost per unit of producing and delivering its products
and attracting and retaining its customers.
Economies of scope are created when a business leverages its current strategic
positioning and/or capabilities to expand into new markets, introduce new product
categories, or launch brand-new businesses while also decreasing the average cost per
unit of producing and delivering its products and attracting and retaining its customers.
Economies of scale and scope enable a company to generate increasing returns and
higher margins as the company grows.4
Despite high-profile examples such as Apple?s Steve Jobs and Microsoft?s Bill Gates, many
people assume that entrepreneurs aren?t suited for sustained growth. Entrepreneurial leaders
who launch a startup, the thinking goes, are unable to switch their approach to meet the needs
of their growing businesses. In other words, sprinters can?t become marathoners. But others
claim that the skills required for growth can be learned and entrepreneurs can continue to
effectively lead their businesses as they grow. As venture capitalist John Hamm argues, ?A
leader who scales is able to jettison habits and skills that have outlived their usefulness and
adapt to new challenges along the way.?5 As this reading discusses, entrepreneurs like Nick
Swinmurn, the founder of Zappos, may choose to step aside and leave the scaling of the
business to a leadership team that is ready, willing, and able to exploit the company?s
potential. Other entrepreneurs, like Marla Malcolm Beck and Barry Beck, the co-founders of
Bluemercury, may choose to stay with the business, acquire new skills and capabilities, and
bring on the resources their growing company needs.
This reading explores how leaders develop strategies, build capabilities, design their
organizations, and address leadership and governance issues as they transition to growth and
pursue increased scale and scope. The lessons and insights in this reading apply to
entrepreneurs who have launched new ventures and want to continue running them as they
grow and to leaders in established companies who have recently acquired an entrepreneurial
venture or are attempting to launch a high-growth business inside their organizations.
Entrepreneurial leadership in established businesses is discussed in more detail in Core
Reading: Leading Breakthrough Innovation in Established Companies (HBP No. 5272).
As we explore the challenges and opportunities of growth, we?ll look in detail at
entrepreneurial leaders of three businesses. Two of them achieved economies of scale as they
expanded their existing businesses and then achieved economies of scope as they expanded
into new products and markets. The third business demonstrates the challenges that
entrepreneurial leaders face as they attempt to increase the scope of their business.
Supplement 3.1, ?A Day in the Life of Two Entrepreneurial Leaders,? provides video
footage of the CEO and COO of an entrepreneurial venture as it transitions to growth in a
rapidly changing business environment. After analyzing the strengths and weaknesses of the
leaders in the video, you will have an opportunity to consider your personal strengths and
weaknesses as leaders or potential leaders of high-growth businesses.
Supplement 3.2, ?Do Managers Matter in 21st-Century High-Growth Businesses?? uses the
example of Google?s transition to growth to explore the role of middle managers in today?s
8082 | Core Reading: LEADING HIGH-GROWTH VENTURES
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This document is authorized for use only by Korey Hernandez in MGMT 614 Entrepreneurship:Growth Strategies-1 taught by ELIZABETH SIKKENGA, Eastern Michigan University from Jan
2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
high-growth Internet companies that are leveraging the power of new technologies to remain
independent as they grow to become dominant players in their industry.
Supplement 3.3, ?Strategic Growth Options,? describes an approach to analyzing strategic
growth options using financial options theory.
2 ESSENTIAL READING
2.1 Transitioning to Growth
What?s dangerous is not to evolve.
?Jeff Bezos6
Startups play a major role in economies around the world. Research by the Kauffman
Foundation on 2007 US census data, for instance, has shown that during 2007 young firms
(one to five years old) accounted for nearly two-thirds of job creation in the United States: 8
million of the 12 million jobs created that year.7 But most startups fail to survive as standalone firms. In the United States, recent research shows that only 19% of firms founded
between 1977 and 1999 were still in existence as stand-alone firms in 2005.8
In an attempt to help entrepreneurs launch ventures that can serve as engines of global
economic growth, a group of serial entrepreneurs and advisers launched the Startup Genome
project. Initial findings from the group?s research suggest that as many as 74% of the failures
of high-growth Internet startups are the result of premature scaling.9 Exhibit 1 shows various
ways that startups can stumble in the timing and sequencing of their scaling efforts. Core
Reading: Experimenting in the Entrepreneurial Venture (HBP No. 8077) discusses how to
avoid many of these issues.
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2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
EXHIBIT 1 Causes of Unsuccessful Scaling
Dimension
Causes of Failure to Scale
Customer
Spending too much on customer acquisition before product-market fit and a repeatable,
scalable business model
Overcompensating for missing product-market fit with marketing and press
Product
Building a product without problem-solution fit
Investing in scalability of the product before product-market fit
Adding ?nice to have? features
Team
Hiring too many people too early
Hiring specialists before they are critical: CFOs, customer service reps, database specialists,
etc.
Hiring managers (VPs, product managers, etc.) instead of doers
Having more than one level of hierarchy
Financials
Raising too little money to get through the valley of death
Raising too much money. This isn?t necessarily bad, but it usually makes entrepreneurs
undisciplined and gives them the freedom to prematurely scale other dimensions (i.e.,
overhiring and overbuilding). Raising too much is also riskier for investors, who should give
startups only as much as they actually need and then wait to see how they progress.
Business
Model
Focusing too much on profit maximization too early
Spending too much time on planning, or executing without a regular feedback loop
Not adapting the business model to a changing market
Failing to focus on the business model and then finding out that costs exceed revenue at scale
Source: Max Marmer, Bjoern Lasse Herrmann, Ertan Dogrultana, Ron Berman, ?Startup Genome Project Report Extra on Premature Scaling,?
Compass, August 29, 2011.
Avoiding the pitfalls of premature scaling is critical when launching new ventures, but it is
also important to recognize that, while the experience of growing a business is very different
from that of launching one, the analytical tools entrepreneurs use to define their initial
business models are similar to the ones used to evaluate growth opportunities. When
launching a new venture, a founder turns an idea into an opportunity by developing a
business model. This model must articulate the venture?s strategy, identify how it will gain
access to the resources and build the capabilities it needs to execute the strategy, and define
how it will deliver value to stakeholders.10 Evaluating growth options also requires an analysis
of strategy, capabilities, and value. But, entrepreneurial leaders whose businesses are
transitioning to growth must also consider what can be leveraged from the venture?s existing
strategic position (its position in the market and its role in a business network or ecosystem)
and the venture?s existing capabilities (operating platform, knowledge assets, talent, organization, leadership, and governance). The value the business generates in terms of stakeholder
relationships and loyalty and cash flow can also be leveraged to finance growth. Exhibit 2
illustrates the links between the business-model analytics used to launch a venture and those
used to identify opportunities to leverage current strategy, capabilities, and value when
transitioning to growth. These sources of leverage?combined with intellectual property,
products, capabilities and know-how?are proprietary assets that provide strategic advantage
while also enabling a business to generate economies of scale and scope.
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2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
EXHIBIT 2 Using Business-Model Analytics to Identify Growth Opportunities
The experiences of the entrepreneurial leaders of three ventures help frame the challenges
entrepreneurs face as they transition from experimentation to growth?first by scaling their
existing business and then by expanding its scope. As you read these stories, consider how the
actions of these entrepreneurial leaders led to success or, in some cases, failure.
Bluemercury: Leading High Growth in Turbulent Times
The first example is Bluemercury, a high-end beauty products retailer that built a network of
physical retail stores that offer spa services and integrated this store network with online retail
offerings. a The co-founders, Marla Malcolm Beck, the CEO and visionary behind the
company, and Barry Beck, the COO, launched Bluemercury as an online business in 1999, at
the height of dot-com fever. The founders recognized flaws in their original online business
model and, in the economic downturn that followed the dot-com crash, they seized the
opportunity to acquire two physical retail store/spas in their Washington, D.C.,
neighborhood.
a
Note that the Bluemercury logo starts with a lowercase ?b,? but the company name is written with a capital ?B? in
text.
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This document is authorized for use only by Korey Hernandez in MGMT 614 Entrepreneurship:Growth Strategies-1 taught by ELIZABETH SIKKENGA, Eastern Michigan University from Jan
2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
By 2001, Bluemercury?s online-offline experiment was generating positive cash flow, and
the co-founders recognized that it was time to transition to growth. They began by scaling
their current business, raising angel financing to open additional stores in large urban centers
along the East Coast.11 During this time, the two married and started a family. Marla Malcolm
Beck jokes about how key events in their personal lives linked with key events in their
business: ?We were married and had our first child at store 5, we had our second child at store
8, and our son came as we launched stores 13 to 20.?12
By the end of 2005, revenue had grown to $17 million, almost doubling from year-end
2004. In spring 2006, the founders sold just over 75% of Bluemercury to a private equity firm
at a pre-money valuation of $62 million. As a term of the sale, the co-founders retained their
positions as CEO and COO. By selling a majority share in the company to private equity
investors, the founders were able to take some of their personal wealth out of the business and
reduce their personal risk as they attempted to rapidly scale the business beyond the initial
offering while continuing to run Bluemercury as an independent business.
As part of the deal, cash was allocated to continue growing Bluemercury. At the time of the
financing, the strategy called for opening almost 300 Bluemercury stores throughout the
United States over the next few years?not just in high-end downtown neighborhoods, but
also in high-end shopping malls.13 Through careful tracking of operations, however, the
founders noted a downward trend in same-store sales. At the same time, careful scanning of
the economy indicated a growing credit bubble. As such, this continued careful business
model analysis?not just of their growth opportunity but also of their existing business?led
the co-founders to decide that it was not the time to pursue aggressive growth. After careful
discussion, the board agreed. As a result, by late 2007, while most were still investing in real
estate, the Becks had cancelled contracts to open more stores and, instead, had begun to cut
cost in the existing stores. Consequently, when the stock market crashed in late 2008,
Bluemercury had the cash it needed to weather the downturn and remain profitable during
the global economic recession.
In 2009, as Bluemercury celebrated its 10th anniversary, the company was back on its
growth trajectory. This time, however, the Becks did not just continue opening new stores;
instead, they also expanded the scope of Bluemercury?s business model by launching an ecofriendly cosmetic line under the M-61 brand. The new product line leveraged the company?s
existing strategic position and its existing online-offline operating platform, enabling
Bluemercury to expand its playing field and thus achieve economies of scope.
In 2014, as Bluemercury celebrated its 15th anniversary, the company had over 500
employees and was finalizing plans to expand its highly successful M-61 product line to
international markets, to launch new beauty brands, and to begin a Bluemercury beauty
television network. To finance this expansion, in early 2015 the founders announced that they
had agreed to sell Bluemercury to Macy?s for $210 million in cash. At the time, the company
had grown to 59 stores in 18 states across the United States and was generating over $100
million in annual revenue. ?Our plan is to operate and significantly expand Bluemercury
stores as an independent business,? Barry Beck explained, while taking advantage of Macy?s
825 physical stores as a new channel for its M-61 products. ?This is a unique time in beauty
innovation,? Marla Malcolm Beck said. ?You?ll be seeing a lot of new testing and
experimenting [of our] brands around the country.?14
Telepizza: Challenges of Shifting from Scale to Scope
Now let?s consider Leo Fernandez and the launch and growth of Telepizza.15 In the mid-1980s,
while working as a country sales manager for Johnson & Johnson in Spain, Fernandez
recognized an opportunity to build a successful pizza franchise, which he called Telepizza. He
founded the company in the fall of 1987 by opening a pizza shop close to his home and soon
8082 | Core Reading: LEADING HIGH-GROWTH VENTURES
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This document is authorized for use only by Korey Hernandez in MGMT 614 Entrepreneurship:Growth Strategies-1 taught by ELIZABETH SIKKENGA, Eastern Michigan University from Jan
2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
opened a second one nearby. Having experimented and refined the concept, in 1988 he quit
his job at J&J and transitioned Telepizza from experimentation to growth. To do so, he used
the business?s strategic position at the time to penetrate its existing market (families in large
Spanish cities) with its existing product (takeout pizza and healthy side dishes). As he scaled
the business in Spain, Fernandez leveraged the capabilities he had refined when running his
first two stores even as he built the leadership, organization, and governance capabilities that
would be needed to support rapid growth. He achieved economies of scale by keeping the
individual pizza stores lean and focused on serving local customers while centralizing the
sourcing, product manufacturing, marketing, and corporate services functions (such as HR,
IT, and finance) at headquarters. He also added regional directors, who supervised and trained
local pizza store operating managers. He financed growth during this stage through cash flow
and franchising, and he leveraged the value of the Telepizza brand to attract new franchise
owners and the staff for new pizza stores.
As he was scaling Telepizza in Spain, Fernandez also began expanding internationally. But
as he entered nearby Portugal and more distant Latin America, Fernandez found that the
centralized dough- and cheese-manufacturing capabilities and the management systems and
organization that had served him so well in Spain could not be leveraged to support global
operations. In addition, customer needs and expectations were different in these new markets,
so he was unable to apply the knowledge he had gained and the product and service delivery
concept he had perfected in Spain. In the end, Fernandez?s international growth options
faltered. So, too, did his attempts to launch new restaurant concepts?including TeleGrill and
TeleOriental in Spain. Having financed these growth options from the equity value of a very
successful initial public offering (IPO) in the late 1990s, Fernandez was shocked to see how
quickly the news of the failed international expansion and new restaurant concepts caused his
stock price to plummet. Within one year of announcing his new growth plan, Fernandez was
forced to resign as CEO and sell his equity stake in Telepizza. The new private equity owners
did not pursue the new restaurant concepts and they slowed international growth. But they
leveraged another portfolio company, TeleChef, to launch an online retail channel, which
greatly expanded distribution of fresh pizza and healthy side dishes from Telepizza?s existing
stores and its central kitchens to new customers in hotels, businesses, and other locations.
Zappos: Leveraging Scale to Increase Scope
Finally, let?s consider the growth and evolution of Zappos, an online retailer named after the
Spanish word for shoes, zapatos. Launched in June 1999 by Nick Swinmurn, a 26-year-old
marketing manager, the company was founded to fulfill a personal vision?to deliver
outstanding customer service to people who wished to shop for and buy all types of shoes
from a single location. By early 2000 Zappos carried 150 brands and had 400,000 pairs of
shoes in stock and a loyal base of customers. While other e-commerce startups went out of
business during the dot-com collapse in 2000 and 2001, Zappos increased its 2001 gross
revenue to more than $8 million; in 2002 gross revenue had risen to over $30 million.
Even as investors fled the dot-com markets, Swinmurn secured his first round of venture
capital (VC) financing from a small Silicon Valley VC firm started by two successful
technology entrepreneurs, Tony Hsieh and Alfred Lin.16 As Hsieh spent time with Zappos, he
decided to become more involved, noting that Zappos was the ?most fun and most promising
of all his investments.?17 In May 2001 Hsieh became co-CEO with Swinmurn; in 2003 he
became the sole CEO, Lin became CFO, and Swinmurn moved to a nonexecutive chairman
position.
As revenue continued to increase, it became clear that Zappos was outgrowing its startup
offices and team. In 2005 Sequoia Capital invested $35 million to build the capabilities needed
to scale the company?s call center and distribution center. The investment also provided the
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2022 to Jul 2022.
For the exclusive use of K. Hernandez, 2022.
financing Zappos needed to move its headquarters from Silicon Valley to Henderson, Nevada
(just outside Las Vegas), and to move its fulfillment center from Silicon Valley to Louisville,
Kentucky. Though many thought Las Vegas and Louisville were unlikely locations for a highgrowth online retailer, Hsieh and Lin believed that the large pool of people accustomed to
working in 24/7 jobs in Las Vegas would be ideal for staffing a 24-hour call center?at a much
lower cost than building and staffing a call center in Silicon Valley. Hsieh and Lin also
recognized that locating their fulfillment center in Louisville?whose airport and river port
were foreign-trade zones?provided local access to Worldport, UPS?s air hub, which allowed
them to receive shipments without clearing customs until after product was sold. In addition,
locating in a foreign-trade zone made it a federal crime to remove anything from the
distribution center?a key risk in fulfillment centers?while offering significant tax
advantages. At the time of the move, Swinmurn decided to remain in Silicon Valley, and Lin
expanded his role to become COO as well as CFO.
Even as they built the capabilities and organization needed to dramatically increase scale,
in 2006 Hsieh and Lin also leveraged their strategic positioning, capabilities, and access to
capital to expand the scope of Zappos?s product line, initially by selling athletic apparel (a new
category for the existing market). This was a natural choice, since 30% of Zappos?s sales were
athletic shoes, and within one year the company had scaled its new apparel business to include
more than 300 brands.
During 2006 Hsieh and Lin further expanded Zappos?s scope by launching a business that
provided website design and hosting and fulfillment services for other retailers. The business,
Powered by Zappos (PBZ), leveraged Zappos?s existing strategic positioning and capabilities to
turn the company?s suppliers into customers and to generate other new revenue streams. Wit