S w

907E18

PFM DEVICES — COMPLEX PROJECT INITIATIVES

Mark Embry and Timothy Kayworth wrote this case solely to provide material for class discussion. The authors do not intend to
illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other
identifying information to protect confidentiality.

Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of
this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to
reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of
Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca.

Copyright © 2007, Ivey Management Services Version: (A) 2007-09-06

In 2002, Jeff R. Goodman, chief executive officer (CEO) of PFM Devices, Inc. (PFM Devices) launched
his final strategic initiative before his upcoming retirement. PFM Devices, a privately held business,
launched 10 years earlier with venture capital investments, had proved to be a successful investment.
Goodman’s past experience in the medical industry, along with his marketing successes, was instrumental
in gaining market share in a competitive global market for the artificial cartilage industry. Although his
market share in the United States had steady growth over the last two years, Goodman had trouble
extending his product on a global scale. Cultural differences and already established companies in both the
European and Asian markets added to the inability to expand outside of the United States.

A NEW OBJECTIVE, A NEW LEADER

Goodman thought the best way to expand globally was to acquire competing companies already
established in areas of growth and market stability. After meeting with the principle investors and gaining
their approval for his new objective, Goodman successfully acquired a smaller competing company in
France and a fast-growing company in Japan that was successfully establishing market share throughout
the Far East. With the completion of both acquisitions near the end of 2002, PFM Devices’ global market
share jumped from 17 per cent to 33 per cent. Consolidated revenues in 2003 were more than $204 million.
Goodman’s plan was on target and created the momentum he needed for the company to continue to
increase market share, revenues and global presence long after his anticipated retirement.

On January 1, 2004, Gary Lunde assumed the CEO position with full approval of the investment partners.
Having been with the company as vice-president of marketing from the beginning, Lunde accepted the
challenge to lead the company to continued prosperity and growth. With the acquisitions completed in
growth-potential markets, he quickly created three divisions based on geographic locations, cultural
variances and the different distribution models used by each location. Lunde’s direction after creating the
three divisions was to let each division operate totally autonomously for supporting business processes,
such as corporate finance, human resources (HR) and information technology (IT) operations. Lunde
concentrated his efforts on consolidating sales, marketing and product manufacturing.
Page 2 9B07E018

PFM DEVICES

In 1992, at the age of 55, Jeff Goodman had a total knee replacement as a result of severe arthritis. His
speedy recovery was greatly enhanced by the use of synthetic cartilage. As a result of his successful
surgery and recovery, he became a staunch advocate for the product and saw an opportunity to start his
own business. Having been in the medical industry for 24 years, Goodman found it simple to convince a
group of venture capitalist to fund his new initiative. Goodman knew the mission before the first employee
was hired, “To create and advance medical products that improve quality of life with pain-free movement.”

SynCart was the first synthetic cartilage product that PFM Devices offered to the market. SynCart was
made from the same material used to make contact lenses, hydrogel and implants for knee, ankle and foot
joints. Chronic arthritis in hips and knees is a widespread disease in large parts of the world, caused by the
wearing of cartilage in the joints. Actual human cartilage acts as a shock absorber in the joints but wear or
accidents can cause the surface to break down, and the cartilage to wear down to the bone. The treatment
available today is palliation and relief, and the last resort is an operation to replace the entire joint with an
artificial one. SynCart was developed to replace worn-out cartilage surfaces, restoring mobility and
relieving joint pain.

DISTRIBUTION MODELS

Cartica, based in Paris, had built an excellent subsidiary distribution model (see Exhibit 1) and had offices
in every strategic European country. All licenses and regulatory mandates had been established with each
country while establishing and opening a new office in each strategic location and country. This
distribution model was exactly what Goodman was looking for to easily get his product to market
throughout Europe.

Japan’s Pacmedi was on the growth fast track. Pacmedi was a new player in the synthetic cartilage industry
but had built market share rapidly. Using a distribution model (see Exhibit 1), Pacmedi used well-known
distributors and had long-term contracts (seven years) with partners in Japan, South Korea, India, Australia
and China. These contracts, signed the end of 2000, included conditions that Pacmedi would repurchase
product at a discount if market share were to drop significantly; however, no inventory controls were
stipulated in the event a distributor wanted to “stock the shelves.” These distributors allowed Pacmedi to
focus on creating a market and name for the product without having to worry about how to get the product
to market.

Finally, the U.S. operations used an agency model (see Exhibit 1). Each agency was independently owned
and employed its own sales forces. Agencies were not barred from selling other medical products but were
prevented from selling a direct competitor’s product. Unlike distributors who purchased product from PFM
Devices, agencies operated on consignment inventory and therefore did not purchase the product until it
was actually used. This methodology created the need for a specialized billing process from PFM Devices
to the agency. Agencies were given defined regional territories and financial incentives based on product
sold. It was not unusual for an agency to “overstock” its warehouse since it could order as much product it
felt was needed without penalties. Exhibit 2 depicts the three distribution models used by PFM Devices in
the global distribution of its synthetic cartilage products.
Page 3 9B07E018

IT PORTFOLIO AND INFRASTRUCTURE

Having acquired two new companies in 2002, Gary Lunde felt the information technology teams in each
division were doing the best they could but lacked leadership and business direction. Lunde hired Betty L.
Brewer as chief information officer (CIO) in the spring of 2004 to manage the global IT team. Exhibit 3
shows the senior management organizational structure at the time of Brewer’s hiring. Previous global
experience in the retail industry was a key to her hiring but she had little experience with the medical
device industry and had a lot to learn. Prior to Brewer’s arrival, each IT department worked for the chief
financial officer (CFO) of its division. Brewer’s first task was to conduct a worldwide assessment of PFM
Device’s IT operations. The results of Brewer’s 100-day assessment were outlined in a memorandum to
Lunde (see Exhibit 4).

In July 2004, after reviewing the memo with his executive team, Lunde and his executive management
team agreed to all of Brewer’s recommendations. During the meeting, Brewer pointed out the need to
increase the global IT budget. Brewer was given a 2005 global operating budget of $9.2 million and a
capital budget of $5.0 million for new IT assets. Brewer was very busy through the end of 2004 and well
into 2005 sourcing requests for proposals (RFPs) for help desk software, creating disaster recovery (DR)
policies, negotiating with hardware vendors and overseeing proper project methodology in all cases. In the
fall of 2005, Brewer felt good about her global IT operations and how her changes had brought PFM
Devices to what she thought was an efficient organization.

A CHANGE OF FOCUS

Lunde sat in his office well after 6:00 p.m. on January 20, 2006, having just received the financial numbers
for the year ending 2005. It was no surprise to him that PFM Devices was not doing as well as expected.
Reviewing the consolidated profit and loss statement (see Exhibit 5) in front of him solidified that fact. He
knew it was past time that PFM Devices take decisive action to reverse this trend. The next week, Lunde
led his executive team in a series of strategy meetings in order to turn his company around. The results of
the long meeting were four short-term business objectives to be completed either within the year or as soon
as possible. The four objectives were as follows:

1. Increase market share by two per cent from 33 per cent to 35 per cent
2. Decrease operating expenses to less than 62 per cent of sales
3. Increase access and visibility to financial, inventory and sales data on a worldwide basis
4. Reduce inventory levels globally by 10 per cent

After many discussions and several late-night meetings, the executive team focused on two major projects
that they agreed would help to reverse the financial loss. Half the executive team behind Lunde and Terri
Freeman, the vice-president of marketing, felt a customer relationship management (CRM) software
solution would aid the company in tracking customers and building strong relationships with end users.
The idea was that by getting closer to the end user (i.e. the customer), word would spread, revenues would
increase and therefore market share should increase. Freeman agreed to be the executive sponsor on the
project, and Brewer was responsible for the successful implementation of the final solution.

The other half of the executive team behind Kent Southerland, CFO, believed that a data warehouse would
reduce costs by increasing access and visibility to real-time data, decisions could be made much quicker
and inventory control would be greatly increased on a global scale. Consolidating sales, financial and
inventory data on a global scale was also a very complex initiative. Most of the inventory and sales data in
Page 4 9B07E018

Europe was not timely and could not be accessed easily since it was located at each individual office. In
addition, inventory control procedures would be reviewed and altered where needed. Controlling inventory
at U.S. agencies and European subsidiaries would be a change management challenge as well as
automation issue.

Money was tight and personnel resources were stretched thin with daily tasks, so it was a unanimous
decision to initiate one project as soon as possible and the other project after the implementation of the
first. The question for debate was which project would have the biggest impact within the shortest amount
of time. Increasing revenue via the CRM project would have a compounding effect every year. When
revenues are rising, profits are also rising and the fact that cost inefficiencies and suspect business
processes might cause margins to decline slightly tend to become secondary. Reducing cost via a data
warehouse project was also a viable solution as the company tried to shed expenses.

Everyone looked at Brewer to make her recommendation. She was fully aware of how complex and
expensive each project would be and wanted to make the best decision possible. Brewer recommended
additional time to research options and come back to the team in a few weeks with her recommendation.
As she thought about this decision, Brewer knew she would need hard numbers regarding project costs and
benefits to make her case (see Exhibit 6). However, she wondered to herself, “Would it be enough?”
Page 5 9B07E018

Exhibit 1

PFM DEVICES DISTRIBUTION MODELS

Distribution models represent how products flow from the producer to the end customer. PFM Devices
used three different distribution models as described below.

Subsidiary Model (Europe)

A subsidiary model is one where various subsidiaries are wholly owned and managed entirely by the
holding company. The sales staff is a part of the company and is managed and paid by the subsidiary. All
billing and collections are performed by the subsidiary.

Agency Model (United States)

An agency is not owned or managed by the holding company but is contracted with the producer to sell
product. The agency supplies and manages a sales force to sell products and may sell products from other
producers but typically cannot sell competing products. Agencies will warehouse product and are
responsible for the logistics from the warehouse to the customer. With PFM Devices, agencies do not
purchase the product until the product is used by the customer. Billing and collections are performed by the
agency.

Distribution Model (Asia)

A distributor purchases product from PFM Devices at a significant discount and is responsible for sales,
marketing, billing and collections. Distributors may sell competing products and, like agencies, are
responsible for logistics from their warehouse to the customer.

Source: Interview with chief information officer of PFM Devices, November 2006.
Page 6 9B07E018

Exhibit 2

PFM DEVICES’ DISTRIBUTION CHANNELS

Corporate

US
U.S. Europe Asia
Operations Operations Operations

Agency Subsidiary Distributor

Customer Customer Customer Customer

Customer Customer
Customer Customer Customer Customer
Customer Customer

Agency Subsidiary

Customer Customer Customer Customer Distributor

Customer Customer Customer Customer

Customer Customer
Agency Subsidiary
Customer Customer

Customer Customer Customer Customer

Customer Customer Customer Customer

Source: Company files.

Page 7 9B07E018

Exhibit 3

ORGANIZATION CHART

Jeff R Goodman
Retired CEO

Gary Lunde
CEO

Betty L Brewer Terri Freeman Kent Southerland Mark Sanchez

CIO EVP Marketing CFO COO

General Mgr
Asia

General Mgr
Europe

General Mgr
US
U.S.
Source: Company files.
Page 8 9B07E018

Exhibit 4

100-DAY ASSESSMENT OF WORLDWIDE IT OPERATIONS FOR PFM DEVICES

Memorandum PFMDevices
To: Gary Lunde

cc: PFM Devices executive staff

From: Betty L. Brewer

Date: June 18, 2004

Subject: 100 Day Global IT Assessment

I wanted to take this opportunity to update you on my assessment of the IT operations. I have personally visited the
three divisions and met with the CFO, IT staff and operations manager in each location. I also had the opportunity to
visit an agency in Chicago and distributor in Japan to find out about their experiences with PFM. In order to give you
a complete report, I must break down the assessment by division, followed by my overall conclusions.

France Operations:
France is using a customized ERP system that is running on Intel based servers. The application was developed
several years ago using FoxPro, an older Microsoft development tool. This ERP application is primarily running AP,
AR, Billing, Credit and Finance. Inventory tracking and control are done at the local subsidiary level and no visibility to
subsidiary inventory is accessible real-time. Once the product is ordered by the subsidiary and fulfilled, that product
tracking and control becomes the responsibility of the local subsidiary.

The IT budget for 2003 was $898,891 and included a staff of 9 employees. Their primary duties are to maintain the
1
custom application and desktop support. They are in and have been in a defensive strategy for several years and
their infrastructure is not current to today’s standard. The immediate concern is disaster recovery. They have
inadequate procedures for backups and have no documented plan for recovery if the applications or hardware were
to be completely destroyed. Desktop PCs and servers were purchased in 1999 and 2000. Although they are running,
there has been no investment made to increase IT capacity and efficiencies.

Japan Operations:
Japan is using a well known ERP software named SAP. SAP has very good market share in Japan and is supported
by three local developers with major enhancements and upgrades outsourced to a consulting firm when necessary.
Japan utilizes the full application suite including Financial and Manufacturing modules. In addition to the three
developers, there are nine IT staff personnel who support the IT infrastructure. The IT budget for 2003 was
$2,594,743. After personnel costs, the biggest portion of the budget is for SAP licenses, outsourcing contracts and
hardware maintenance contracts. Japan has been in an offensive IT strategy and continues to be innovative in their
use of technology.

1
See Exhibit 7 for a further discussion of offensive versus defensive IT strategies.
Page 9 9B07E018

Exhibit 4 (continued)

Similar to our European operations, the operations in Japan lack procedures in disaster recovery, business continuity
and IT governance. Because IT has been on the fast track to get the IT infrastructure built and SAP operational, little
attention has been made for sustaining business should a disaster occur. Various departments are constantly
requesting IT to lead new projects based on technology and there is no method to select the correct project.

US Operations:
The US operation is using an ERP suite of applications from Oracle. Like SAP, Oracle is a market leader and offers a
full suite of applications to run a business. We have successfully improved our business processes across the
company by implementing this software in 2002. Since we have an agency distribution model, we have customized
the inventory tracking process both in the corporate office and at each agency site. These expensive but needed
customizations allow our partner agencies to efficiently order, receive product and track inventory, sales and
commissions. It is to our advantage to meticulously track inventory at each agency location since we still own and
account for the inventory until it is used. In speaking with Harvey Reed, the agency owner from our Chicago agency
commented, “We are able to order with a click of a button and have real time access to our inventory. We have not
missed an order or have ever been in a position to find it necessary to back order product.” Although this new
application is seen as an industry advantage from our agencies, I have noticed an increase in inventory levels at each
agency location. This new application and feature may be too easy for them to order product with very few constraints
from corporate distribution.

The IT budget for the US operations in 2003 was $3,356,024. The IT staff consists of 16 full time personnel with 5
Oracle support developers, 5 network and server administrators, 2 Database administrators, 2 for desktop support
and 2 IT managers. We are heavy in technology support but I feel we need to increase our support to all employees.
Our average time to respond to a request for help is 3 – 5 days, totally unacceptable for this organization.

Short-Term Focus and Conclusion:

I recommend that we develop a short term goals list for each division.

Starting with France, we should update the infrastructure and desktop systems. Although the older custom ERP
system is running, we do not have a sufficient infrastructure to support moving to an updated ERP system. We should
update the network backbone, servers and many of the older desktop PCs. We should begin thinking about replacing
the current business software with one more compatible with the US and Japan organizations. In addition to
infrastructure upgrades, immediate focus must be put on disaster recovery and risk mitigation.

Our focus in Japan should be in disaster recovery, business continuity and IT governance. We do not have enough
staff or budget to start every IT project requested and developing proper IT governance will correct the frustrations for
all departments. Like France, we must implement proper disaster recovery procedures to ensure our investment in IT
and data is sound.

For the US operation, our immediate need is to increase our headcount and strengthen our ability to support all our
employees in a timely manner. We should investigate and implement the correct help desk tracking system for PFM
Devices. In addition, we should also focus on disaster recovery procedures and processes. We have too much at
stake to lose to faulty processes.

Source: Company files.

Page 10 9B07E018

Exhibit 5

THREE-YEAR CONSOLIDATED PROFIT AND LOSS STATEMENT FOR PFM DEVICES

3-Year Financials:
Consolidated Operations 2005 2004 2003

Sales 211,713,405 215,913,732 204,366,997

Cost of Sales 30,997,843 31,782,501 30,777,670
Profit 180,715,562 184,131,231 173,589,327
Operating Expenses
G&A 146,003,439 137,668,782 128,806,041
R&D 37,528,196 33,411,786 34,968,378
Total Operating Expenses 183,531,635 171,080,568 163,774,419
Earnings (loss) before Tax (2,816,073) 13,050,663 9,814,908

US Operations 2005 2004 2003

Sales 84,285,362 85,319,733 81,456,902
Cost of Sales 10,957,097 11,157,570 9,157,508
Profit 73,328,265 74,162,163 72,299,394
Operating Expenses
G&A 55,249,068 50,367,522 52,955,734
R&D 15,484,133 13,463,988 12,566,938
Total Operating Expenses 70,733,201 63,831,510 65,522,672
Earnings (loss) before Tax 2,595,064 10,330,653 6,776,722

European Operations 2005 2004 2003

Sales 39,881,754 38,090,717 36,991,433
Cost of Sales 6,598,336 5,542,377 4,517,891
Profit 33,283,418 32,548,340 32,473,542
Operating Expenses
G&A 33,395,283 29,621,619 29,445,699
R&D 5,651,102 4,532,906 1,432,677
Total Operating Expenses 39,046,385 34,154,525 30,878,376
Earnings (loss) before Tax (5,762,967) (1,606,185) 1,595,166

Asian Operations 2005 2004 2003

Sales 87,546,289 92,503,282 85,918,662
Cost of Sales 13,442,410 15,082,554 17,102,271
Profit 74,103,879 77,420,728 68,816,391
Operating Expenses
G&A 57,359,088 57,699,641 46,404,608
R&D 16,392,961 15,414,892 20,968,763
Total Operating Expenses 73,752,049 73,114,533 67,373,371
Earnings (loss) before Tax 351,830 4,306,195 1,443,020

Source: Company files.

Page 11 9B07E018

Exhibit 6

ESTIMATED PROJECT COSTS AND BENEFITS

Market Position:
Market annual growth rate: 1%
Target market share end of 2007: 35%
Data Warehouse IT Investment Project
Estimated Cost Benefit Analysis

2006 2007 2008 2009 2010 2011

Benefits
Cost Savings 2,000,000 2,080,000 2,163,200 2,249,728 2,339,717

Capital/Development Costs
Computers & Servers 720,000
Software Package/Development 212,500
Consulting Fees 1,030,000
Network Upgrades 600,000
ISP Capital Expenses 100,000
Misc Costs 143,000
Total Development Costs 2,805,500
Operating Costs
Consulting Fees 515,000 257,500 130,000 70,000 50,000
Additional Staff 125,000 131,250 137,813 144,703 151,938
ISP Fees 35,000 35,000 35,000 35,000 35,000
SW & HW Annual Maint fees 139,875 160,856 184,985 212,732 244,642
Misc Supplies & Costs 2,000 2,000 2,000 2,000 2,000
Total Operating Costs 816,875 586,606 489,798 464,435 483,580

Annual Increase in:

Project Cost 5.0%
Inventory Cost Saving 4.0%

CRM IT Investment Project

Estimated Cost Benefit Analysis

2006 2007 2008 2009 2010 2011

Benefits
Increase Revenue 2,600,000 2,860,000 3,146,000 3,460,600 3,806,660

Capital/Development Costs
Computers & Servers 530,000
Software Package/Development 595,000
Consulting Fees 1,236,000
Network Upgrades 665,000
ISP Capital Costs 628,000
Misc Costs 1,301,300
Total Development Costs 4,955,300
Operating Costs
Consulting Fees 618,000 310,000 155,000 80,000 50,000
Additional Staff 320,750 336,788 353,627 371,308 389,874
ISP Fees 35,000 35,000 35,000 35,000 35,000
SW & HW Annual Maint fees 168,750 194,063 223,172 256,648 295,145
Misc Supplies & Costs 12,000 12,000 12,000 12,000 12,000
Total Operating Costs 1,154,500 887,851 778,799 754,956 782,019

Annual Increase in:

Revenue 10.0%
Costs 5.0%
Source: Company files.
Page 12 9B07E018

Exhibit 7

OFFENSIVE / DEFENSIVE IT STRATEGY

IT strategy can be divided into two basic categories: offensive and defensive.1 Defensive IT involves a
reliable, efficient system that runs smoothly while costs remain under control. The majority use of the IT
budget is for ongoing IT operations. The CIO’s views shift from system uptime to process uptime, from
captive constituency to options to outsource, and from assisting in top line growth to cost stability.

An offensive IT strategy uses technology to gain or sustain competitive advantage, to leapfrog competition
with new innovation and to seek significant process improvements or cost reductions. Offensive strategies
usually invest in promising technologies but it is often hard to identify risks and to predict if a technology
project will fail. Additionally, CIOs are unable to predict, with consistency, return on investment (ROI) or
return on sales (ROS).

According to a 2005 benchmark study, average overall IT spending was 3.6 per cent of revenue. A typical
company usually spends 25 per cent of operation budget on building new business functionalities but the
company would be better valued if it spent 40 per cent on new business and innovation.2 According to
Forrester Research, Inc., IT budgets have two components: innovation capacity and IT “MOOSE,” which
can be categorized as offensive and defensive strategies, respectively. In defensive mode, a company
usually spends 20 per cent on new initiatives, whereas it spends 80 per cent on maintenances, operations,
organizations, systems and equipments (MOOSE). To move from defensive to offensive strategy, a
company must break the status quo (so that it can radically transform the occurrence of tasks, processes or
interactions) and show applied business values (such as increased revenue, reduction in cost and cycle
time, and broadened market opportunities).

A smooth transition from defensive to offensive strategy can be attained by focusing on innovation
capacity rather than on fixed percentage spending of revenue so that, over time, innovation will reduce
costs. It is possible to grow innovation capacity despite having a constant IT spending budget, thus,
transforming from maintenance to innovation will add value and have greater impact on the company,
customers or business partners.

1
Richard Nolan and R. Warren McFarlan, “Information Technology and the Board of Directors,” Harvard Business Review,
October 2005, pp. 96–107.
2
Laurie Orlov, Making the Most of IT’s Innovation Capacity, Forrester Research, Inc., Cambridge, MA, 2005.