SUNRISE MEDICAL INC.

S WHEELCHAIR PRODUCTS A GLANCE AT THE WHEELCHAIR INDUSTRY IN 1993 Despite being a young industry, the wheelchair business showed a large amount of growth in a ten year span in terms of sales. By 1992, worldwide sales were approximately US 800 million, with half of these numbers coming from sales in the US while the rest were concentrated in Europe. These numbers were an indicator of the potential the industry had and this was confirmed by projected sales growth, which ranged between 5% to 15% annual increases for different product lines. There was excitement as an important US insurance program announced it would reimburse more money for wheelchairs of higher price, fact that could boost sales in the near future. Although sales potential was attractive, profitability margins were still low because costs ranged between 65% and 75% and additional operating expenses ranged from 23% to 34% of sales (exhibit 1). The market was dominated by three major players, who combined accounted for an average of 70% of the market share. As sales potential rose, two of the three competitors (Sunrise Medical and Invacare) kept delivering positive net margins through product innovation, competitive sales strategies, acquisitions and efficiencies in lowering costs. The remaining main competitor, Everest and Jennings, was lagging behind with four straight years of negative margins and ongoing concerns about its viability in the medium term. This meant that, if Sunrise Medical and Invacare continued to improve the strategies that had E&J struggling for its future, they could continue gaining market share and growing in the wheelchair business. The short term looked like a two player game, although neither of the two seemed to set itself apart from the other with a dominant advantage. Given that both had turned into leading players in the industry in a short period of time, it was not unlikely for other competitors to enter the game. If a new company

decided to enter the industry, it could copy Invacares model of building a manufacturing plant where costs were low although this meant investing several million dollars or it could become an assembler through a low initial investment and, albeit higher costs, compete with an efficient sales and marketing strategy and gain market share progressively. Although the barriers of entry in the wheelchair industry were not too high in 1993, the product itself had no relevant substitutes in the market. Both leading companies also produced other mobility products and medical equipment such as crutches and walkers that could be used as substitutes, but did not have the sales potential or the usefulness wheelchairs did. They were also involved in the making and sales of wheelchair parts, and in the latter years they were becoming more standardized to fit wheelchairs made by competitors, leading to a more homogeneous industry thus making it harder for substitute products to be developed. Companies that manufactured their own products, like Sunrise Medical and Invacare, had a competitive market advantage because efficiencies in their production processes could lead to lower prices and higher sales volume. Since raw materials accounted for up to 80% of production costs and there were many suppliers in the market, the bargaining purchase power was in their hands. Even for assemblers that did not have their own manufacturing plants, there were several companies that would sell them prefabricated parts. On the buyers side, there were three main distribution channels that had more negotiation power than suppliers; two of the three channels had a few buyers that concentrated most of the purchasing on each channel, situation that had led to deep discounts and reductions on retail prices during the last years. Home medical equipment dealers had achieved price decreases of 15% followed by medical distributors

with a 5% decrease and rehab suppliers with 2%. This meant that manufacturers must maintain and develop a competitive cost structure to keep up with volume sales and growth. Increasing sales potential, coupled with few competitors, negotiation power with suppliers and no apparent substitutes, made the industry attractive for existing players. As buyers had gained great power and prices were forced to drop, cost efficiency became more relevant; this made it harder for new competitors to enter the game, albeit not impossible. The key was to continue developing sales with the distribution channels hoping to slow down falling prices, and take advantage of the bargaining power with suppliers to get raw materials and prefabricated parts to be cheaper, getting net margins to rise. Innovation also played a key role in the industry and it had helped both Sunrise and Invacare develop new models to stay competitive and increase sales. QUICKIE VS INVACARE Quickies wheelchairs competed in the most innovative segments of the industry: it dominated the Ultralight segment with a 49% market share, it had a competitive market share of 24% in the Power and Pediatric segment and it was developing its brand in the Lightweight Standard which was dominated by Invacare (Quickie held a 12% market share vs. Invacares 57%). Altogether, these three segments accounted for 67% of US market sales and had the greatest potential for forecasted growth in sales (exhibit 2). Quickie was historically an innovating company and this had had a positive effect on sales and a differentiation effect from Invacare during the latter years; Quickie invented the Lightweight Standard category, although it lagged in market share, as well as the Ultralight category, in which it was the leader. Its designs in the Power and Pediatric category were considered to be a growing, original trend.

Proof of its innovative ways was Quickies introduction of a new power model featuring new functionalities, and although its market release was temporarily stalled by the FDA, if approved it would sell at a great price and generate additional revenue. Quickie also developed a strong relationship with the rehab suppliers distribution channel, which did not offer discounts from retail prices; this stood out as another advantage as the other two channels were the ones that pushed for the strongest price drops. On top of this, Quickie had the lowest costs structure among all competitors, which made Sunrise the company with the highest gross margin in the market. These market advantages were mostly due to Quickies business strategy: first it was all about high quality, customizable products that enhanced efficient costs structures and improved cash flows through the elimination of finished products inventory. It also developed great relationships with its customers and consumers, cultivating a great service policy that resulted in high levels of customer satisfaction. Innovation was fostered through its pursuit of excellence program, involving every area of the company thus creating a highly collaborative scenario. Employees were also important, helping keep up their morale along with competitive salaries and excellent incentives; this resulted in enhanced productivity and eventually a virtuous circle that would lead back to the factors stated above. Invacare has focused mainly on improving production techniques to achieve maximum cost reduction. In 1983 it made an attempt to acquire Quickie but the negotiations never prospered because, according to Quickies founders, the value-system developed at Sunrise was more appealing and aligned with their business model; Invacare was a big manufacturer while Quickie showed a different approach to business beyond mass production. The companys CEO was a retired military who, during the early eighties, executed a well thought out plan to bring down its competition through heavy volume discounts and other customer benefits. It engaged in a price war with E&J until it opened up a production facility in

1989 in Mexico; since then, E&J has not been able to keep up with its competitors low costs, however Invacare is still to outperform Quickies low productions costs. SUNRISES DECISION Albeit still dominant in the Lightweight Standard segment, Sunrises corporate strategy looked more solid than Invacares in 1993. The segments with the most promising growth perspectives in the wheelchair industry were Lightweight Standard, Ultralight and Power and Pediatric, and Invacare was strong in only one of them. If Sunrises Guardian division enters the Lightweight Standard wheelchair market, it is more likely to steal from Invacares 57% market share than from Sunrises 13%; this would help Sunrise gain more market in two of the high growth categories, with a good chance of continuing to gain share in the Power category if the new model is to be approved by the FDA. It is also important to keep in mind that Quickies customer and marketing strategy revolved around younger people, while Guardians focused on the elderly. This could explain Quickies low market share in the Lightweight Standard category whose main users were typically the senior, and it would also reinforce Guardians argument to enter this market segment. One downside to Guardians entry into the Lightweight Standard category is its youth in the wheelchair industry as well as it high cost structure (72% compared to Quickies 62% of sales, view exhibit 1). It subcontracted fabrication to a Taiwanese company, experiencing a series of quality and delivery issues as well as higher costs. Despite these factors, Guardian and Quickie belonged to the same company, Sunrise. If they produce the same product and one of them has a cost control advantage and knows the market better, sharing best practices and implementing them at Guardian is a realizable alternative. Both shared the same principles that had led to Quickies success in terms of quality, customer service and employee satisfaction, which would drive both to start taking over Invacares market share in the Lightweight Standard line, take full

advantage of Medicares new policy of reimbursement for these models as well as other factors resulting in forecasted 15% annual growth rates in sales. Guardian could maintain its focus on the elderly market while Quickie could continue delivering high quality products to its younger audience. Invacares response to new product introduction by competition has historically been of engaging in price decreases through heavy discounts, introducing a new product themselves or acquiring a firm to generate growth. Since most product lines were already developed and Invacare was not much of an innovator, it was likely to put more price pressures on the market to counteract heavy competition from Sunrise. Whatever the case, Sunrises strategy of divisional autonomy could be kept since it had proved effective until 1993, however operational and financial synergies between both divisions should be developed if they were about to compete with each other.
EXHIBIT 1 Ratios Financial indicators COGS SG&A Net Interest Other expenses Taxes Net Income USD millions Sales COGS Gross Margin SG&A Net Interest Other expenses Taxes Net Income

1992 E&J 75.50% 34.00% 4.70% 5.00% -1.60% -17.70%

1992 1993 1993 Invacare Sunrise (Quickie) Sunrise (Guardian) 68.10% 62.00% 72.00% 22.90% 22.00% 20.00% 0.00% 1.30% 1.30% 1.40% 0.50% 0.00% 3.20% 3.60% 3.60% 5.80% 9.70% 2.60%

1993 Sunrise 63.90% 24.80% 1.30% 0.70% 3.60% 5.70%

107.1 80.9 24.5% 36.4 5.0 5.4 -1.7 -19.0

305.2 207.8 31.9% 69.9 0.0 0.0 9.8 17.7

319.2 204.0 36.1% 79.2 4.1 2.2 11.5 18.2

EXHIBIT 2 Market Share E&J Invacare Sunrise (Quickie) Sunrise (Guardian) Others
Three main competitors

Standard 23% 48% 0% 2% 27% 73%

Lightweight Standard

Ultralight 0% 12% 49% 0% 39% 61%

16% 57% 13% 0% 14% 86%

Power & Pediatric 16% 29% 24% 0% 31% 69%