FINANCE

After your analysis of the case, prepare a response to the following questions:

1) Which innovation characteristics could Apple leverage to manage resistance to future generations of Apple Watch?

2) Discuss the role of propagation mechanisms in reducing resistance to Apple Watch?

3) What are the consumer characteristics that Apple needs to influence to overcome consumer resistance to its smartwatch?

4) Discuss the barriers and sources of active and passive innovation resistance in the context of Apple Watch.

5) Discuss various consumer segments that arise from variation in resistance.

In your response to these questions, be as thorough as possible. In case analysis, you always want to support your answers with a cited source. In addition, utilize material from the chapter readings in your response.  Post your 5+ page (double-spaced) response to these questions by Saturday at 11:55 p.m.

©2015 by the Kellogg School of Management at Northwestern University. This case was prepared by Kyle Bell ’15 under the supervision of Professor Russell Walker. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. To order copies or request permission to reproduce materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail custserv@hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Kellogg Case Publishing.

RUSSELL WALKER AND KYLE BELL ’15 KEL919

Nestlé Ice Cream in Cuba

Elsewhere in ice cream, we inaugurated a new factory in Cuba in April.

With those thirteen words buried deep in the company’s 2003 annual report, Nestlé announced to the global investor community that it was officially open for business in Cuba. The announcement had been a long time coming. In 1996, as the Castro regime began welcoming limited international investment back to the island, Nestlé signed a letter of intent with the Cuban government to build an ice cream factory in Havana’s El Cotorro neighborhood. The plant, a joint venture between the Cuban government and Nestlé, was to produce high-quality helados for tourists and affluent Cubans.1

Nearly twenty years after this initial decision to enter the Cuban market, it was not clear how successful the investment had been and what the future might hold for Nestlé on the island. The 2014 announcement of intentions to normalize diplomatic relations between Washington and Havana made answering these questions increasingly urgent, as U.S. companies began to eye the Cuban market and existing foreign investors in Cuba prepared for new competitive threats and expanded market opportunities.

Stakeholders inside and outside Nestlé needed to evaluate the firm’s investment in Cuba as well as its strategy for future growth.

Nestlé

Tracing its roots to the establishment of the Anglo-Swiss Condensed Milk Company in 1866, Nestlé grew to become one of the world’s leading consumer products companies. By 2014, the company had grown to over 300,000 employees and reached approximately $100 billion in annual sales; its market capitalization eclipsed $250 billion in early 2015 and the company reported a return on equity of 23 percent globally.2 Many analysts labeled the Swiss firm the world’s largest food and beverage company (see Exhibit 1).3

1 “Nestlé, Coralsa Make Ice Cream Together,” CubaNews, June 1, 2003. 2 Nestlé, “Key Figures,” http://www.nestle.com/aboutus/keyfigures (accessed May 1, 2015); “Nestlé SA,” Financial Times, http://markets.ft.com/ research/Markets/Tearsheets/Financials?s=NESN:VTX (accessed September 14, 2015); “Nestlé: Food Giant with Compelling Dividend,” Seeking Alpha, http://seekingalpha.com/article/2469755-nestle-swiss-food-giant-with-compelling- dividend (accessed September 14, 2015). 3 For example, “World’s Most Admired Companies 2015,” Fortune, http://fortune.com/worlds-most-admired-companies/nestle-33 (accessed May 27, 2015); Alexander Hess, “Companies that Control the World’s Food,” USA Today, August 16, 2014.

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This document is authorized for use only by Yinan Hong in Global Marketing Summer 2016 taught by Lawrence K Duke, Drexel University from June 2016 to December 2016.

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2 KELLOGG SCHOOL OF MANAGEMENT

As Nestlé grew, the firm’s product portfolio dramatically expanded. For nearly seventy years, the company specialized in condensed milk and infant cereal. It was not until the 1930s that Nestlé launched successful businesses in powdered beverages and instant coffee (Milo in 1934 and Nescafé in 1938).4 Rapid innovation and numerous acquisitions accelerated the growth of Nestlé’s portfolio over the ensuing decades. By 2015, the company sold over 3,000 brands in thirteen distinct product categories ranging from bottled water to pet care (see Exhibit 2).

In addition to product diversification, international expansion helped fuel Nestlé’s corporate growth in the twentieth century. As of early 2015, Nestlé operated in 197 countries, giving the firm global scale and extensive experience navigating new markets. The firm divided the world into three main operating regions: Europe, Americas, and Asia/Oceania/Africa. Nestlé Americas accounted for 43 percent of corporate sales and employed 33 percent of Nestlé workers; the region also earned a trade operating profit margin of 18.8 percent in 2014, compared with a corporate trade operating profit of 15.5 percent over the same period (see Exhibit 3).5 While a significant portion of Nestlé’s sales came from developed economies such as the United States and the EU, the company also built strong businesses in China, Mexico, Brazil, and the Philippines (see Exhibit 4) and was a pioneer in formerly closed markets such as Myanmar.6

Nestlé’s stated corporate strategy focused on transforming the company into a global leader in nutrition, health, and wellness. The firm planned to use its brand portfolio, research and development capabilities, global reach, and talent to deliver healthy results for both consumers and investors. In particular, Nestlé’s leadership identified four potential growth areas for the firm: nutrition, emerging markets, out-of-home consumption, and “premiumization”7 (see Exhibit 5). The firm planned to apply this roadmap to all business units and markets.8

Despite this nutritional focus, ice cream was an important part of the company portfolio. Nestlé sold ice cream and ice cream–based products under the Nestlé brand and other well-known brands such as Häagen-Dazs, Edy’s, Dreyer’s, and Skinny Cow. “Milk products and ice cream” was the firm’s second-highest selling category after powdered beverages, accounting for 18 percent of global revenue and 28 percent of regional sales in the Americas (see Exhibit 6). Ice cream products alone made up 4.5 percent of 2014 corporate sales and earned a trade operating profit of 16.4 percent that year.9

Surprisingly, Nestlé ice cream may have succeeded in part because of the firm’s new health and wellness goals. In 2010 the company began selling a new line of smaller-scale ice cream cups under the Dreyer’s, Häagen-Dazs, and Skinny Cow brands in the United States as a way of translating key elements of its strategic roadmap to the U.S. ice cream business. The cups provided portion control (wellness), were portable (on-the-go consumption), and allowed consumers to buy a range of interesting flavors (customization, premiumization). Following a concerted retailing campaign, the new cup line became a successful part of Nestlé’s U.S. ice

4 Nestlé, “About Us: Key Dates,” http://www.nestle.com/aboutus/keydates (accessed May 27, 2015). 5 Nestlé 2014 Annual Report. 6 Peter Vanham, “Nestlé: Nescafé for Myanmar,” beyondbrics (blog), Financial Times, October 5, 2012. 7 Nestlé defines “premiumization” as a strategy for “enhancing consumers’ lives, whilst creating additional value per consumption moment: many consumers are not looking to eat and drink more; they are looking to eat and drink better.” Nestlé, “The Nestlé Roadmap to Good Food, Good Life,” http://www.nestle.com/asset-library/Documents/About_Us/Nestle_Roadmap.pdf (accessed September 25, 2015). 8 Nestlé, “About Us: Strategy,” http://www.nestle.com/aboutus/strategy (accessed June 1, 2015). 9 Ibid.

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This document is authorized for use only by Yinan Hong in Global Marketing Summer 2016 taught by Lawrence K Duke, Drexel University from June 2016 to December 2016.

KEL919 NESTLÉ ICE CREAM IN CUBA

KELLOGG SCHOOL OF MANAGEMENT 3

cream business, increasing cup category sales by 35 percent in the first six months after the launch.10

Foreign Investment in Cuba

In the nearly six decades since the Cuban Revolution, the Cuban government’s positions on foreign investment—and economic policy in general—had shifted dramatically, bringing important changes for multinational companies operating in or evaluating opportunities on the island (see Exhibit 7).11

The early years of the regime were characterized by Soviet-style central planning and expropriations of foreign assets. Foreign investment was largely discouraged, as the regime sought to assert national economic sovereignty. Nevertheless, in the 1990s, after the fall of the Soviet Union, Cuba suffered an economic crisis and the Castro regime was forced to change the country’s policies to prevent economic collapse and maintain power. The government liberalized regulations on foreign investment and Fidel Castro made personal appeals to attract multinational companies. The change was short-lived. As the economy began to recover by the early 2000s, the Castro regime reversed its position towards foreign investment, canceled joint venture contracts, allowed input prices to spike, and halted other market-oriented policies. Between 2002 and 2008 the number of foreign joint ventures in Cuba fell by half (see Exhibit 8).12 After taking power in 2008, Raúl Castro passed a number of economic reforms, including a new foreign investment law that reinforced—and perhaps even advanced—policies of the 1990s.

Under Cuban law, foreign investment could take three forms: joint ventures, international economic associations, and wholly owned foreign ventures. Joint ventures between the government and a foreign multinational were the most common. All business ventures were required to be approved by the Cuban government; approval was granted for a fixed time period (typically ten or fifteen years) after which the government could, and often did, change the investment terms. The limited approval period and threat of renegotiation had important implications for project valuations and financing, lowering the potential net present value of investment opportunities, incentivizing higher levels of debt, and discouraging investment towards the end of the approval period.13

To complicate matters further, foreign companies also had to grapple with Cuba’s dual currency system. Cuba had two forms of legal tender: the convertible peso (CUC) and the Cuban peso (CUP). The CUC, which was pegged to the U.S. dollar, was approximately twenty-five times as valuable as the CUP. Cubans were paid in CUPs and used them for everyday purchases. However, most imported products—often sold through government-run retailers called “dollar stores”—were priced in CUCs, and tourists visiting the island paid for food, hotels, and services with CUCs.14

10 Decision Insight, “Nestlé’s Merchandising Location Strategy Wins with Retailers,” 2010. 11 Carmelo Mesa Lago, Cuba en la Era de Raúl Castro [Cuba in the Era of Raúl Castro] (Madrid: Editorial Colibrí, 2012). 12 Richard Feinberg, “The New Cuban Economy: What Roles for Foreign Investment?” Latin America Initiative at Brookings Institute, December 2012. 13 Ibid. 14 For more information on Cuba’s dual-currency system, please see “Cuba to Ditch Complicated Dual-Currency System,” World Finance, January 21, 2014.

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This document is authorized for use only by Yinan Hong in Global Marketing Summer 2016 taught by Lawrence K Duke, Drexel University from June 2016 to December 2016.

NESTLÉ ICE CREAM IN CUBA KEL919

4 KELLOGG SCHOOL OF MANAGEMENT

The currency system had important labor and marketing implications for foreign companies operating in Cuba. First, all employees in Cuba were hired by a government employment agency, which essentially “loaned” employees to firms. Foreign firms paid employee wages to the government agency in CUCs and the agency, in turn, paid the employees in CUPs; Richard Feinberg, a Cuba scholar at the Brookings Institute, called this the “world’s heaviest tax on labor.”15 Second, the currency system affected product pricing and customer segmentation. Foreign firms often sold products only in CUCs, which effectively made the products unaffordable for most ordinary Cubans and led many foreign firms to target tourists. During the first wave of foreign investment in Cuba, annual tourism to the island was modest—only 750,000 international visitors came to Cuba in 1995. By 2014, however, nearly 3 million international travelers came to Cuba, spending a total of 18 million nights on the island (Exhibit 9).16

Given these obstacles, foreign direct investment in Cuba was small and lagged far behind similarly sized emerging markets (see Exhibit 10). Cumulative net investment flowing to the island was estimated to be $2 billion to $3.5 billion by 2009.17 The number of firms operating in Cuba was also relatively small: in 2011, approximately 250 foreign-owned joint ventures operated in Cuba versus 911 in Chile, 754 in Croatia, 2,761 in Malaysia, 5,144 in Portugal, and 2,049 in Taiwan.18

Tourism, energy, and mining made up 55 percent of foreign investment in Cuba, and some of the largest international players on the island were from these sectors (e.g., Sol Melia, a Spanish hotel chain, and Sherritt, a Canadian nickel miner).19 Scholars classified these types of investments as “resource-seeking,” since they entered the market in order to capitalize on location-specific natural resources.20 Investment by “market-seeking” consumer goods companies, on the other hand, was relatively small. For example, only 7 percent of foreign-owned businesses in Cuba operated in the food sector (see Exhibit 11). This dearth of consumer goods companies indicated the operational challenges of producing consumables in Cuba and the limitations of the domestic Cuban consumer market.

Nestlé Joint Venture

In this challenging environment, Nestlé saw an opportunity to manufacture and market premium ice cream. The firm formally agreed to enter the Cuban market during the brief reform period of the 1990s, signing a letter of intent with the Castro regime to build an ice cream factory on the island. The agreement established a new joint venture called Coralac, which would be owned 60 percent by Nestlé and 40 percent by Coralsa, a government ministry that invested in

15 Feinberg, “The New Cuban Economy: What Roles for Foreign Investment?” 16 Oficina Nacional de Estadisticas de Cuba, Turismo 2014, http://www.one.cu/aec2013/esp/15_tabla_cuadro.htm (accessed June 1, 2015). 17 Feinberg, “The New Cuban Economy: What Roles for Foreign Investment?” 18 Ibid. 19 Ministerio del Comercio Exterior y la Inversión Extranjera (MINCEX), “Cartera de Oportunidades de Inversión Extranjera” [Portfolio of Foreign Investment Opportunities], 2014. 20 For a theoretical summary of FDI, please see Chiara Franco et. al. “Why Do Firms Invest Abroad? An Analysis of the Motivations Underlying FDI,” University of Bologna, August 2008.

For the exclusive use of Y. Hong, 2016.

This document is authorized for use only by Yinan Hong in Global Marketing Summer 2016 taught by Lawrence K Duke, Drexel University from June 2016 to December 2016.

KEL919 NESTLÉ ICE CREAM IN CUBA

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