The best prepared plans can result in a project failure because of poor execution. Project execution involves the working relationships among the participants and whether or not they support project management. There are two critical working relationships: the project–line manager interface and the project–executive management interface.
There are other factors that can affect the execution of a project. These include open communications, honesty, and integrity in dealing with customers, truth in negotiations, and factual status reporting. Execution can also be influenced by the quality of the original project plan. A project plan based on faulty or erroneous assumptions can destroy morale and impact execution.
The Blue Spider Project
“This is impossible! Just totally impossible! Ten months ago I was sitting on top of the world. Upper-level management considered me one of the best, if not the best, engineer in the plant. Now look at me! I have bags under my eyes, I haven’t slept soundly in the last six months, and here I am, cleaning out my desk. I’m sure glad they gave me back my old job in engineering. I guess I could have saved myself a lot of grief and aggravation had I not accepted the promotion to project manager.”
Gary Anderson had accepted a position with Parks Corporation right out of college. With a Ph.D. in mechanical engineering, Gary was ready to solve the world’s most traumatic problems. At first, Parks Corporation offered Gary little opportunity to do the pure research that he eagerly wanted to undertake. However, things soon changed. Parks grew into a major electronics and structural design corporation during the big boom of the late 1950s and early 1960s when Department of Defense (DoD) contracts were plentiful.
Parks Corporation grew from a handful of engineers to a major DoD contractor, employing some 6,500 people. During the recession of the late 1960s, money became scarce and major layoffs resulted in lowering the employment level to 2,200 employees. At that time, Parks decided to get out of the R&D business and compete as a low-cost production facility while maintaining an engineering organization solely to support production requirements.
After attempts at virtually every project management organizational structure, Parks Corporation selected the matrix form. Each project had a program manager who reported to the director of program management. Each project also maintained an assistant project manager—normally a project engineer—who reported directly to the project manager and indirectly to the director of engineering. The program manager spent most of his time worrying about cost and time, whereas the assistant program manager worried more about technical performance.
With the poor job market for engineers, Gary and his colleagues began taking coursework toward MBA degrees in case the job market deteriorated further.
In 1995, with the upturn in DoD spending, Parks had to change its corporate strategy. Parks had spent the last seven years bidding on the production phase of large programs. Now, however, with the new evaluation criteria set forth for contract awards, those companies winning the R&D and qualification phases had a definite edge on being awarded the production contract. The production contract was where the big profits could be found. In keeping with this new strategy, Parks began to beef up its R&D engineering staff. By 1998, Parks had increased in size to 2,700 employees. The increase was mostly in engineering. Experienced R&D personnel were difficult to find for the salaries that Parks was offering. Parks was, however, able to lure some employees away from the competitors, but relied mostly upon the younger, inexperienced engineers fresh out of college.
With the adoption of this corporate strategy, Parks Corporation administered a new wage and salary program that included job upgrading. Gary was promoted to senior scientist, responsible for all R&D activities performed in the mechanical engineering department. Gary had distinguished himself as an outstanding production engineer during the past several years, and management felt that his contribution could be extended to R&D as well.
In January 1998, Parks Corporation decided to compete for Phase I of the Blue Spider Project, an R&D effort that, if successful, could lead into a $500 million program spread out over 20 years. The Blue Spider Project was an attempt to improve the structural capabilities of the Spartan missile, a short-range tactical missile used by the Army. The Spartan missile was exhibiting fatigue failure after six years in the field. This was three years less than what the original design specifications called for. The Army wanted new materials that could result in a longer life for the Spartan missile.
Lord Industries was the prime contractor for the Army’s Spartan Program. Parks Corporation would be a subcontractor to Lord if they could successfully bid and win the project. The criteria for subcontractor selection were based not only on low bid, but also on technical expertise as well as management performance The Blue Spider Project Kickoff
on other projects. Park’s management felt that it had a distinct advantage over most of the other competitors because they had successfully worked on other projects for Lord Industries.
THE BLUE SPIDER PROJECT KICKOFF
On November 3, 1997, Henry Gable, the director of engineering, called Gary Anderson into his office.
Henry Gable: “Gary, I’ve just been notified through the grapevine that Lord will be issuing the RFP for the Blue Spider Project by the end of this month, with a 30-day response period. I’ve been waiting a long time for a project like this to come along so that I can experiment with some new ideas that I have. This project is going to be my baby all the way! I want you to head up the proposal team. I think it must be an engineer. I’ll make sure that you get a good proposal manager to help you. If we start working now, we can get close to two months of research in before proposal submittal. That will give us a one-month’s edge on our competitors.”
Gary was pleased to be involved in such an effort. He had absolutely no trouble in getting functional support for the R&D effort necessary to put together a technical proposal. All of the functional managers continually remarked to Gary, “This must be a biggy. The director of engineering has thrown all of his support behind you.”
On December 2, the RFP was received. The only trouble area that Gary could see was that the technical specifications stated that all components must be able to operate normally and successfully through a temperature range of –65 °F to 145 °F. Current testing indicated the Parks Corporation’s design would not function above 130 °F. An intensive R&D effort was conducted over the next three weeks. Everywhere Gary looked, it appeared that the entire organization was working on his technical proposal.
A week before the final proposal was to be submitted, Gary and Henry Gable met to develop a company position concerning the inability of the preliminary design material to be operated above 130 °F.
Gary Anderson: “Henry, I don’t think it is going to be possible to meet specification requirements unless we change our design material or incorporate new materials. Everything I’ve tried indicates we’re in trouble.”
Gable: “We’re in trouble only if the customer knows about it. Let the proposal state that we expect our design to be operative up to 155 °F. That’ll please the customer.” Anderson: “That seems unethical to me. Why don’t we just tell them the truth?”
Gable: “The truth doesn’t always win proposals. I picked you to head up this effort because I thought that you’d understand. I could have just as easily selected one of our many moral project managers. I’m considering you for program manager after we win the program. If you’re going to pull this conscientious crap on me like the other project managers do, I’ll find someone else. Look at it this way; later we can convince the customer to change the specifications. After all, we’ll be so far downstream that he’ll have no choice.”
After two solid months of sixteen-hour days for Gary, the proposal was submitted. On February 10, 1998, Lord Industries announced that Parks Corporation would be awarded the Blue Spider Project. The contract called for a ten-month effort, negotiated at $2.2 million at a firm-fixed price.
SELECTING THE PROJECT MANAGER
Following contract award, Henry Gable called Gary in for a conference.
Gable: “Congratulations, Gary! You did a fine job. The Blue Spider Project has great potential for ongoing business over the next ten years, provided that we perform well during the R&D phase. Obviously you’re the most qualified person in the plant to head up the project. How would you feel about a transfer to program management?”
Anderson: “I think it would be a real challenge. I could make maximum use of the MBA degree I earned last year. I’ve always wanted to be in program management.”
Gable: “Having several masters’ degrees, or even doctorates for that matter, does not guarantee that you’ll be a successful project manager. There are three requirements for effective program management: You must be able to communicate both in writing and orally; you must know how to motivate people; and you must be willing to give up your car pool. The last one is extremely important in that program managers must be totally committed and dedicated to the program, regardless of how much time is involved.
“But this is not the reason why I asked you to come here. Going from project engineer to program management is a big step. There are only two places you can go from program management—up the organization or out the door. I know of very, very few engineers who failed in program management and were permitted to return.”
Anderson: “Why is that? If I’m considered to be the best engineer in the plant, why can’t I return to engineering?”
The Work Begins
Gable: “Program management is a world of its own. It has its own formal and informal organizational ties. Program managers are outsiders. You’ll find out. You might not be able to keep the strong personal ties you now have with your fellow employees. You’ll have to force even your best friends to comply with your standards. Program managers can go from program to program, but functional departments remain intact.
“I’m telling you all this for a reason. We’ve worked well together the past several years. But if I sign the release so that you can work for Grey in program management, you’ll be on your own, like hiring into a new company. I’ve already signed the release. You still have some time to think about it.”
Anderson: “One thing I don’t understand. With all of the good program managers we have here, why am I given this opportunity?”
Gable: “Almost all of our program managers are over forty-five years old. This resulted from our massive layoffs several years ago when we were forced to lay off the younger, inexperienced program managers. You were selected because of your age and because all of our other program managers have worked only on production-type programs. We need someone at the reins who knows R&D. Your counterpart at Lord Industries will be an R&D type. You have to fight fire with fire.
“I have an ulterior reason for wanting you to accept this position. Because of the division of authority between program management and project engineering, I need someone in program management whom I can communicate with concerning R&D work. The program managers we have now are interested only in time and cost. We need a manager who will bend over backwards to get performance also. I think you’re that man. You know the commitment we made to Lord when we submitted that proposal. You have to try to achieve that. Remember, this program is my baby. You’ll get all the support you need. I’m tied up on another project now. But when it’s over, I’ll be following your work like a hawk. We’ll have to get together occasionally and discuss new techniques.
“Take a day or two to think it over. If you want the position, make an appointment to see Elliot Grey, the director of program management. He’ll give you the same speech I did. I’ll assign Paul Evans to you as chief project engineer. He’s a seasoned veteran and you should have no trouble working with him. He’ll give you good advice. He’s a good man.”
THE WORK BEGINS
Gary accepted the new challenge. His first major hurdle occurred in staffing the project. The top priority given to him to bid the program did not follow through for staffing. The survival of Parks Corporation depended on the profits received from the production programs. In keeping with this philosophy Gary found that engineering managers (even his former boss) were reluctant to give up their key people to the Blue Spider Program. However, with a little support from Henry Gable, Gary formed an adequate staff for the program.
Right from the start Gary was worried that the test matrix called out in the technical volume of the proposal would not produce results that could satisfy specifications. Gary had ninety days after go-ahead during which to identify the raw materials that could satisfy specification requirements. Gary and Paul Evans held a meeting to map out their strategy for the first few months.
Anderson: “Well, Paul, we’re starting out with our backs against the wall on this one. Any recommendations?”
Paul Evans: “I also have my doubts about the validity of this test matrix. Fortunately, I’ve been through this before. Gable thinks this is his project and he’ll sure as hell try to manipulate us. I have to report to him every morning at 7:30 A.M. with the raw data results of the previous day’s testing. He wants to see it before you do. He also stated that he wants to meet with me alone.
“Lord will be the big problem. If the test matrix proves to be a failure, we’re going to have to change the scope of effort. Remember, this is an FFP contract. If we change the scope of work and do additional work in the earlier phases of the program, then we should prepare a trade-off analysis to see what we can delete downstream so as to not overrun the budget.”
Anderson: “I’m going to let the other project office personnel handle the administrating work. You and I are going to live in the research labs until we get some results. We’ll let the other project office personnel run the weekly team meetings.”
For the next three weeks Gary and Paul spent virtually twelve hours per day, seven days a week, in the research and development lab. None of the results showed any promise. Gary kept trying to set up a meeting with Henry Gable but always found him unavailable.
During the fourth week, Gary, Paul, and the key functional department managers met to develop an alternate test matrix. The new test matrix looked good. Gary and his team worked frantically to develop a new workable schedule that would not have impact on the second milestone, which was to occur at the end of 180 days. The second milestone was the final acceptance of the raw materials and preparation of production runs of the raw materials to verify that there would be no scale-up differences between lab development and full-scale production.
Gary personally prepared all of the technical handouts for the interchange meeting. After all, he would be the one presenting all of the data. The technical interchange meeting was scheduled for two days. On the first day, Gary presented all of the data, including test results, and the new test matrix. The customer appeared displeased with the progress to date and decided to have its own inhouse caucus that evening to go over the material that was presented.
The Work Begins
The following morning the customer stated its position: “First of all, Gary, we’re quite pleased to have a project manager who has such a command of technology. That’s good. But every time we’ve tried to contact you last month, you were unavailable or had to be paged in the research laboratories. You did an acceptable job presenting the technical data, but the administrative data was presented by your project office personnel. We, at Lord, do not think that you’re maintaining the proper balance between your technical and administrative responsibilities. We prefer that you personally give the administrative data and your chief project engineer present the technical data.
“We did not receive any agenda. Our people like to know what will be discussed, and when. We also want a copy of all handouts to be presented at least three days in advance. We need time to scrutinize the data. You can’t expect us to walk in here blind and make decisions after seeing the data for ten minutes.
“To be frank, we feel that the data to date is totally unacceptable. If the data does not improve, we will have no choice but to issue a work stoppage order and look for a new contractor. The new test matrix looks good, especially since this is a firm-fixed-price contract. Your company will bear the burden of all costs for the additional work. A trade-off with later work may be possible, but this will depend on the results presented at the second design review meeting, 90 days from now.
“We have decided to establish a customer office at Parks to follow your work more closely. Our people feel that monthly meetings are insufficient during R&D activities. We would like our customer representative to have daily verbal meetings with you or your staff. He will then keep us posted. Obviously, we had expected to review much more experimental data than you have given us.
“Many of our top-quality engineers would like to talk directly to your engineering community, without having to continually waste time by having to go through the project office. We must insist on this last point. Remember, your effort may be only $2.2 million, but our total package is $100 million. We have a lot more at stake than you people do. Our engineers do not like to get information that has been filtered by the project office. They want to help you.
“And last, don’t forget that you people have a contractual requirement to prepare complete minutes for all interchange meetings. Send us the original for signature before going to publication.”
Although Gary was unhappy with the first team meeting, especially with the requests made by Lord Industries, he felt that they had sufficient justification for their comments. Following the team meeting, Gary personally prepared the complete minutes. “This is absurd,” thought Gary. “I’ve wasted almost one entire week doing nothing more than administrative paperwork. Why do we need such detailed minutes? Can’t a rough summary suffice? Why is it that customers want everything documented? That’s like an indication of fear. We’ve been completely cooperative with them. There has been no hostility between us. If we’ve gotten this much paperwork to do now, I hate to imagine what it will be like if we get into trouble.”
A NEW ROLE
Gary completed and distributed the minutes to the customer as well as to all key team members.
For the next five weeks testing went according to plan, or at least Gary thought that it had. The results were still poor. Gary was so caught up in administrative paperwork that he hadn’t found time to visit the research labs in over a month. On a Wednesday morning, Gary entered the lab to observe the morning testing. Upon arriving in the lab, Gary found Paul Evans, Henry Gable, and two technicians testing a new material, JXB-3.
Gable: “Gary, your problems will soon be over. This new material, JXB-3, will permit you to satisfy specification requirements. Paul and I have been testing it for two weeks. We wanted to let you know, but were afraid that if the word leaked out to the customer that we were spending their money for testing materials that were not called out in the program plan, they would probably go crazy and might cancel the contract. Look at these results. They’re super!”
Anderson: “Am I supposed to be the one to tell the customer now? This could cause a big wave.”
Gable: “There won’t be any wave. Just tell them that we did it with our own IR&D funds. That’ll please them because they’ll think we’re spending our own money to support their program.”
Before presenting the information to Lord, Gary called a team meeting to present the new data to the project personnel. At the team meeting, one functional manager spoke out: “This is a hell of a way to run a program. I like to be kept informed about everything that’s happening here at Parks. How can the project office expect to get support out of the functional departments if we’re kept in the dark until the very last minute? My people have been working with the existing materials for the last two months and you’re telling us that it was all for nothing. Now you’re giving us a material that’s so new that we have no information on it whatsoever. We’re now going to have to play catch-up, and that’s going to cost you plenty.”
One week before the 180-day milestone meeting, Gary submitted the handout package to Lord Industries for preliminary review. An hour later the phone rang.
Customer: “We’ve just read your handout. Where did this new material come from? How come we were not informed that this work was going on? You know, of course, that our customer, the Army, will be at this meeting. How can we explain this to them? We’re postponing the review meeting until all of our people have analyzed the data and are prepared to make a decision.
“The purpose of a review or interchange meeting is to exchange information when both parties have familiarity with the topic. Normally, we (Lord Industries) require almost weekly interchange meetings with our other customers because we don’t trust them. We disregard this policy with Parks Corporation based on past working relationships. But with the new state of developments, you have forced us to revert to our previous position, since we now question Parks Corporation’s integrity in communicating with us. At first we believed this was due to an inexperienced program manager. Now, we’re not sure.”
Anderson: “I wonder if the real reason we have these interchange meetings isn’t to show our people that Lord Industries doesn’t trust us. You’re creating a hell of a lot of work for us, you know.”
Customer: “You people put yourself in this position. Now you have to live with it.”
Two weeks later Lord reluctantly agreed that the new material offered the greatest promise. Three weeks later the design review meeting was held. The Army was definitely not pleased with the prime contractor’s recommendation to put a new, untested material into a multimillion-dollar effort.
THE COMMUNICATIONS BREAKDOWN
During the week following the design review meeting Gary planned to make the first verification mix in order to establish final specifications for selection of the raw materials. Unfortunately, the manufacturing plans were a week behind schedule, primarily because of Gary, since he had decided to reduce costs by accepting the responsibility for developing the bill of materials himself. A meeting was called by Gary to consider rescheduling of the mix.
Anderson: “As you know we’re about a week to ten days behind schedule. We’ll have to reschedule the verification mix for late next week.”
Production manager: “Our resources are committed until a month from now. You can’t expect to simply call a meeting and have everything reshuffled for the Blue Spider Program. We should have been notified earlier. Engineering has the responsibility for preparing the bill of materials. Why aren’t they ready?”
Engineering integration: “We were never asked to prepare the bill of materials. But I’m sure that we could get it out if we work our people overtime for the next two days.”
Anderson: “When can we remake the mix?”
Production manager: “We have to redo at least 500 sheets of paper every time we reschedule mixes. Not only that, we have to reschedule people on all three shifts. If we are to reschedule your mix, it will have to be performed on overtime. That’s going to increase your costs. If that’s agreeable with you, we’ll try it. But this will be the first and last time that production will bail you out. There are procedures that have to be followed.”
Testing engineer: “I’ve been coming to these meetings since we kicked off this program. I think I speak for the entire engineering division when I say that the role that the director of engineering is playing in this program is suppressing individuality among our highly competent personnel. In new projects, especially those involving R&D, our people are not apt to stick their necks out. Now our people are becoming ostriches. If they’re impeded from contributing, even in their own slight way, then you’ll probably lose them before the project gets completed. Right now I feel that I’m wasting my time here. All I need are minutes of the team meetings and I’ll be happy. Then I won’t have to come to these pretend meetings anymore.”
The purpose of the verification mix was to make a full-scale production run of the material to verify that there would be no material property changes in scaleup from the small mixes made in the R&D laboratories. After testing, it became obvious that the wrong lots of raw materials were used in the production verification mix.
A meeting was called by Lord Industries for an explanation of why the mistake had occurred and what the alternatives were.
Lord: “Why did the problem occur?”
Anderson: “Well, we had a problem with the bill of materials. The result was that the mix had to be made on overtime. And when you work people on overtime, you have to be willing to accept mistakes as being a way of life. The energy cycles of our people are slow during the overtime hours.”
Lord: “The ultimate responsibility has to be with you, the program manager. We, at Lord, think that you’re spending too much time doing and not enough time managing. As the prime contractor, we have a hell of a lot more at stake than you do. From now on we want documented weekly technical interchange meetings and closer interaction by our quality control section with yours.”
Anderson: “These additional team meetings are going to tie up our key people.
I can’t spare people to prepare handouts for weekly meetings with your people.”
Lord: “Team meetings are a management responsibility. If Parks does not want the Blue Spider Program, I’m sure we can find another subcontractor. All you (Gary) have to do is give up taking the material vendors to lunch and you’ll have plenty of time for handout preparation.”
Gary left the meeting feeling as though he had just gotten raked over the coals. For the next two months, Gary worked sixteen hours a day, almost every day. Gary did not want to burden his staff with the responsibility of the handouts, so he began preparing them himself. He could have hired additional staff, but with such a tight budget, and having to remake verification mix, cost overruns appeared inevitable.
As the end of the seventh month approached, Gary was feeling pressure from within Parks Corporation. The decision-making process appeared to be slowing down, and Gary found it more and more difficult to motivate his people. In fact, the grapevine was referring to the Blue Spider Project as a loser, and some of his key people acted as though they were on a sinking ship.
By the time the eighth month rolled around, the budget had nearly been expended. Gary was tired of doing everything himself. “Perhaps I should have stayed an engineer,” thought Gary. Elliot Grey and Gary Anderson had a meeting to see what could be salvaged. Grey agreed to get Gary additional corporate funding to complete the project. “But performance must be met, since there is a lot riding on the Blue Spider Project,” asserted Grey. He called a team meeting to identify the program status.
Anderson: “It’s time to map out our strategy for the remainder of the program. Can engineering and production adhere to the schedule that I have laid out before you?”
Team member, engineering: “This is the first time that I’ve seen this schedule. You can’t expect me to make a decision in the next ten minutes and commit the resources of my department. We’re getting a little unhappy being kept in the dark until the last minute. What happened to effective planning?”
Anderson: “We still have effective planning. We must adhere to the original schedule, or at least try to adhere to it. This revised schedule will do that.”
Team member, engineering: “Look, Gary! When a project gets in trouble it is usually the functional departments that come to the rescue. But if we’re kept in the dark, then how can you expect us to come to your rescue? My boss wants to know, well in advance, every decision that you’re contemplating with regard to our departmental resources. Right now, we . . .”
Anderson: “Granted, we may have had a communications problem. But now we’re in trouble and have to unite forces. What is your impression as to whether your department can meet the new schedule?”
Team member, engineering: “When the Blue Spider Program first got in trouble, my boss exercised his authority to make all departmental decisions regarding the program himself. I’m just a puppet. I have to check with him on everything.”
Team member, production: “I’m in the same boat, Gary. You know we’re not happy having to reschedule our facilities and people. We went through this once before. I also have to check with my boss before giving you an answer about the new schedule.”
The following week the verification mix was made. Testing proceeded according to the revised schedule, and it looked as though the total schedule milestones could be met, provided that specifications could be adhered to.
Because of the revised schedule, some of the testing had to be performed on holidays. Gary wasn’t pleased with asking people to work on Sundays and holidays, but he had no choice, since the test matrix called for testing to be accomplished at specific times after end-of-mix.
A team meeting was called on Wednesday to resolve the problem of who would work on the holiday, which would occur on Friday, as well as staffing Saturday and Sunday. During the team meeting Gary became quite disappointed. Phil Rodgers, who had been Gary’s test engineer since the project started, was assigned to a new project that the grapevine called Gable’s new adventure. His replacement was a relatively new man, only eight months with the company. For an hour and a half, the team members argued about the little problems and continually avoided the major question, stating that they would first have to coordinate commitments with their bosses. It was obvious to Gary that his team members were afraid to make major decisions and therefore “ate up” a lot of time on trivial problems.
On the following day, Thursday, Gary went to see the department manager responsible for testing, in hopes that he could use Phil Rodgers this weekend.
Department manager: “I have specific instructions from the boss (director of engineering) to use Phil Rodgers on the new project. You’ll have to see the boss if you want him back.”
Anderson: “But we have testing that must be accomplished this weekend. Where’s the new man you assigned yesterday?”
Department manager: “Nobody told me you had testing scheduled for this weekend. Half of my department is already on an extended weekend vacation, including Phil Rodgers and the new man. How come I’m always the last to know when we have a problem?”
Anderson: “The customer is flying down his best people to observe this weekend’s tests. It’s too late to change anything. You and I can do the testing.”
Department manager: “Not on your life. I’m staying as far away as possible from the Blue Spider Project. I’ll get you someone, but it won’t be me. That’s for sure!”
The weekend’s testing went according to schedule. The raw data was made available to the customer under the stipulation that the final company position would be announced at the end of the next month, after the functional departments had a chance to analyze it.
Final testing was completed during the second week of the ninth month. The initial results looked excellent. The materials were within contract specifications, and although they were new, both Gary and Lord’s management felt that there would be little difficulty in convincing the Army that this was the way to go. Henry Gable visited Gary and congratulated him on a job well done.
All that now remained was the making of four additional full-scale verification mixes in order to determine how much deviation there would be in material properties between full-sized production-run mixes. Gary tried to get the customer to concur (as part of the original trade-off analysis) that two of the four production runs could be deleted. Lord’s management refused, insisting that contractual requirements must be met at the expense of the contractor.
The following week, Elliot Grey called Gary in for an emergency meeting concerning expenditures to date.
Elliot Grey: “Gary, I just received a copy of the financial planning report for last quarter in which you stated that both the cost and performance of the Blue Spider Project were 75 percent complete. I don’t think you realize what you’ve done. The target profit on the program was $200,000. Your memo authorized the vice president and general manager to book 75 percent of that, or $150,000, for corporate profit spending for stockholders. I was planning on using all $200,000 together with the additional $300,000 I personally requested from corporate headquarters to bail you out. Now I have to go back to the vice president and general manager and tell them that we’ve made a mistake and that we’ll need an additional $150,000.”
Anderson: “Perhaps I should go with you and explain my error. Obviously, I take all responsibility.”
Grey: “No, Gary. It’s our error, not yours. I really don’t think you want to be around the general manager when he sees red at the bottom of the page. It takes an act of God to get money back once corporate books it as profit. Perhaps you should reconsider project engineering as a career instead of program management. Your performance hasn’t exactly been sparkling, you know.”
Gary returned to his office quite disappointed. No matter how hard he worked, the bureaucratic red tape of project management seemed always to do him in. But late that afternoon, Gary’s disposition improved. Lord Industries called to say that, after consultation with the Army, Parks Corporation would be awarded a sole-source contract for qualification and production of Spartan missile components using the new longer-life raw materials. Both Lord and the Army felt that the sole-source contract was justified, provided that continued testing showed the same results, since Parks Corporation had all of the technical experience with the new materials.
Gary received a letter of congratulations from corporate headquarters, but no additional pay increase. The grapevine said that a substantial bonus was given to the director of engineering.
During the tenth month, results were coming back from the accelerated aging tests performed on the new materials. The results indicated that although the new materials would meet specifications, the age life would probably be less than five years. These numbers came as a shock to Gary. Gary and Paul Evans had a conference to determine the best strategy to follow.
Anderson: “Well, I guess we’re now in the fire instead of the frying pan. Obviously, we can’t tell Lord Industries about these tests. We ran them on our own. Could the results be wrong?”
Evans: “Sure, but I doubt it. There’s always margin for error when you perform accelerated aging tests on new materials. There can be reactions taking place that we know nothing about. Furthermore, the accelerated aging tests may not even correlate well with actual aging. We must form a company position on this as soon as possible.”
Anderson: “I’m not going to tell anyone about this, especially Henry Gable. You and I will handle this. It will be my throat if word of this leaks out. Let’s wait until we have the production contract in hand.”
Evans: “That’s dangerous. This has to be a company position, not a project office position. We had better let them know upstairs.”
Anderson: “I can’t do that. I’ll take all responsibility. Are you with me on this?”
Evans: “I’ll go along. I’m sure I can find employment elsewhere when we open Pandora’s box. You had better tell the department managers to be quiet also.”
Two weeks later, as the program was winding down into the testing for the final verification mix and final report development, Gary received an urgent phone call asking him to report immediately to Henry Gable’s office.
Gable: “When this project is over, you’re through. You’ll never hack it as a program manager, or possibly a good project engineer. We can’t run projects around here without honesty and open communications. How the hell do you expect top management to support you when you start censoring bad news to the top? I don’t like surprises. I like to get the bad news from the program manager and project engineers, not secondhand from the customer. And of course, we cannot forget the cost overrun. Why didn’t you take some precautionary measures?”
Anderson: “How could I when you were asking our people to do work such as accelerated aging tests that would be charged to my project and was not part of program plan? I don’t think I’m totally to blame for what’s happened.”
Gable: “Gary, I don’t think it’s necessary to argue the point any further. I’m willing to give you back your old job, in engineering. I hope you didn’t lose too many friends while working in program management. Finish up final testing and the program report. Then I’ll reassign you.”
Gary returned to his office and put his feet up on the desk. “Well,” thought Gary, “perhaps I’m better off in engineering. At least I can see my wife and kids once in a while.” As Gary began writing the final report, the phone rang:
Functional manager: “Hello, Gary. I just thought I’d call to find out what charge number you want us to use for experimenting with this new procedure to determine accelerated age life.”
Anderson: “Don’t call me! Call Gable. After all, the Blue Spider Project is his baby.”
Corwin 1 Corporation
By June 2003, Corwin Corporation had grown into a $950 million per year corporation with an international reputation for manufacturing low-cost, high-quality rubber components. Corwin maintained more than a dozen different product lines, all of which were sold as off-the-shelf items in department stores, hardware stores, and automotive parts distributors. The name Corwin was now synonymous with “quality.” This provided management with the luxury of having products that maintained extremely long life cycles.
Organizationally, Corwin had maintained the same structure for more than fifteen years (see Exhibit I). The top management of Corwin Corporation was highly conservative and believed in using a marketing approach to find new markets for existing product lines rather than exploring for new products. Under this philosophy, Corwin maintained a small R&D group whose mission was simply to evaluate state-of-the-art technology and its application to existing product lines.
Corwin’s reputation was so good that it continually received inquiries about the manufacturing of specialty products. Unfortunately, the conservative nature of Corwin’s management created a “do not rock the boat” atmosphere opposed to taking any type of risks. A management policy was established to evaluate all specialtyproduct requests. The policy required answering yes to the following questions:
Exhibit I. Organizational chart for Corwin Corporation
These stringent requirements forced Corwin to no-bid more than 90 percent of all specialty-product inquiries.
Corwin Corporation was a marketing-driven organization, although manufacturing often had different ideas. Almost all decisions were made by marketing with the exception of product pricing and estimating, which was a joint undertaking between manufacturing and marketing. Engineering was considered as merely a support group to marketing and manufacturing.
For specialty products, the project managers would always come out of marketing even during the R&D phase of development. The company’s approach was that if the specialty product should mature into a full product line, then there should be a product line manager assigned right at the onset.
THE PETERS COMPANY PROJECT
In 2000, Corwin accepted a specialty-product assignment from Peters Company because of the potential for follow-on work. In 2001 and 2002, and again in 2003, profitable follow-on contracts were received, and a good working relationship developed, despite Peters’ reputation for being a difficult customer to work with.
On December 7, 2002, Gene Frimel, the vice president of marketing at Corwin, received a rather unusual phone call from Dr. Frank Delia, the marketing vice president at Peters Company.
Frank Delia: “Gene, I have a rather strange problem on my hands. Our R&D group has $250,000 committed for research toward development of a new rubber product material, and we simply do not have the available personnel or talent to undertake the project. We have to go outside. We’d like your company to do the work. Our testing and R&D facilities are already overburdened.”
Gene Frimel: “Well, as you know, Frank, we are not a research group even though we’ve done this once before for you. And furthermore, I would never be able to sell our management on such an undertaking. Let some other company do the R&D work and then we’ll take over on the production end.”
Delia: “Let me explain our position on this. We’ve been burned several times in the past. Projects like this generate several patents, and the R&D company almost always requires that our contracts give them royalties or first refusal for manufacturing rights.”
Frimel: “I understand your problem, but it’s not within our capabilities. This project, if undertaken, could disrupt parts of our organization. We’re already operating lean in engineering.”
Delia: “Look, Gene! The bottom line is this: We have complete confidence in your manufacturing ability to such a point that we’re willing to commit to a five-year production contract if the product can be developed. That makes it extremely profitable for you.”
Frimel: “You’ve just gotten me interested. What additional details can you give me?”
Delia: “All I can give you is a rough set of performance specifications that we’d like to meet. Obviously, some trade-offs are possible.”
Frimel: “When can you get the specification sheet to me?”
Delia: “You’ll have it tomorrow morning. I’ll ship it overnight express.”
Frimel: “Good! I’ll have my people look at it, but we won’t be able to get you an answer until after the first of the year. As you know, our plant is closed down for the last two weeks in December, and most of our people have already left for extended vacations.”
Delia: “That’s not acceptable! My management wants a signed, sealed, and delivered contract by the end of this month. If this is not done, corporate will reduce our budget for 2003 by $250,000, thinking that we’ve bitten off more than we can chew. Actually, I need your answer within 48 hours so that I’ll have some time to find another source.”
Frimel: “You know, Frank, today is December 7, Pearl Harbor Day. Why do I feel as though the sky is about to fall in?”
Delia: “Don’t worry, Gene! I’m not going to drop any bombs on you. Just remember, all that we have available is $250,000, and the contract must be a firmfixed-price effort. We anticipate a six-month project with $125,000 paid on contract signing and the balance at project termination.”
Frimel: “I still have that ominous feeling, but I’ll talk to my people. You’ll hear from us with a go or no-go decision within 48 hours. I’m scheduled to go on a cruise in the Caribbean, and my wife and I are leaving this evening. One of my people will get back to you on this matter.”
Gene Frimel had a problem. All bid and no-bid decisions were made by a four-man committee composed of the president and the three vice presidents. The president and the vice president for manufacturing were on vacation. Frimel met with Dr. Royce, the vice president of engineering, and explained the situation.
Royce: “You know, Gene, I totally support projects like this because it would help our technical people grow intellectually. Unfortunately, my vote never appears to carry any weight.”
Frimel: “The profitability potential as well as the development of good customer relations makes this attractive, but I’m not sure we want to accept such a risk. A failure could easily destroy our good working relationship with Peters Company.”
Royce: “I’d have to look at the specification sheets before assessing the risks, but I would like to give it a shot.”
Frimel: “I’ll try to reach our president by phone.”
By late afternoon, Frimel was fortunate enough to be able to contact the president and received a reluctant authorization to proceed. The problem now was how to prepare a proposal within the next two or three days and be prepared to make an oral presentation to Peters Company.
Frimel: “The Boss gave his blessing, Royce, and the ball is in your hands. I’m leaving for vacation, and you’ll have total responsibility for the proposal and presentation. Delia wants the presentation this weekend. You should have his specification sheets tomorrow morning.”
Royce: “Our R&D director, Dr. Reddy, left for vacation this morning. I wish he were here to help me price out the work and select the project manager. I assume that, in this case, the project manager will come out of engineering rather than marketing.”
Frimel: “Yes, I agree. Marketing should not have any role in this effort. It’s your baby all the way. And as for the pricing effort, you know our bid will be for $250,000. Just work backwards to justify the numbers. I’ll assign one of our contracting people to assist you in the pricing. I hope I can find someone who has experience in this type of effort. I’ll call Delia and tell him we’ll bid it with an unsolicited proposal.”
Royce selected Dan West, one of the R&D scientists, to act as the project leader. Royce had severe reservations about doing this without the R&D director, Dr. Reddy, being actively involved. With Reddy on vacation, Royce had to make an immediate decision.
On the following morning, the specification sheets arrived and Royce, West, and Dick Potts, a contracts man, began preparing the proposal. West prepared the direct labor man-hours, and Royce provided the costing data and pricing rates. Potts, being completely unfamiliar with this type of effort, simply acted as an observer and provided legal advice when necessary. Potts allowed Royce to make all decisions even though the contracts man was considered the official representative of the president.
Finally completed two days later, the proposal was actually a ten-page letter that simply contained the cost summaries (see Exhibit II) and the engineering intent. West estimated that 30 tests would be required. The test matrix described the test conditions only for the first five tests. The remaining 25 test conditions would be determined at a later date, jointly by Peters and Corwin personnel.
On Sunday morning, a meeting was held at Peters Company, and the proposal was accepted. Delia gave Royce a letter of intent authorizing Corwin
Exhibit II. Proposal cost summaries
Direct labor and support
Testing (30 tests at $2,000 each)
Overhead at 100%
G&A (general and administrative, 10%)
Corporation to begin working on the project immediately. The final contract would not be available for signing until late January, and the letter of intent simply stated that Peters Company would assume all costs until such time that the contract was signed or the effort terminated.
West was truly excited about being selected as the project manager and being able to interface with the customer, a luxury that was usually given only to the marketing personnel. Although Corwin Corporation was closed for two weeks over Christmas, West still went into the office to prepare the project schedules and to identify the support he would need in the other areas, thinking that if he presented this information to management on the first day back to work, they would be convinced that he had everything under control.
THE WORK BEGINS
On the first working day in January 2003, a meeting was held with the three vice presidents and Dr. Reddy to discuss the support needed for the project. (West was not in attendance at this meeting, although all participants had a copy of his memo.)
Reddy: “I think we’re heading for trouble in accepting this project. I’ve worked with Peters Company previously on R&D efforts, and they’re tough to get along with. West is a good man, but I would never have assigned him as the project leader. His expertise is in managing internal rather than external projects. But, no matter what happens, I’ll support West the best I can.”
Royce: “You’re too pessimistic. You have good people in your group and I’m sure you’ll be able to give him the support he needs. I’ll try to look in on the project every so often. West will still be reporting to you for this project. Try not to burden him too much with other work. This project is important to the company.”
West spent the first few days after vacation soliciting the support that he needed from the other line groups. Many of the other groups were upset that they had not been informed earlier and were unsure as to what support they could provide. West met with Reddy to discuss the final schedules.
Reddy: “Your schedules look pretty good, Dan. I think you have a good grasp on the problem. You won’t need very much help from me. I have a lot of work to do on other activities, so I’m just going to be in the background on this project. Just drop me a note every once in a while telling me what’s going on. I don’t need anything formal. Just a paragraph or two will suffice.”
By the end of the third week, all of the raw materials had been purchased, and initial formulations and testing were ready to begin. In addition, the contract was ready for signature. The contract contained a clause specifying that Peters Company had the right to send an in-house representative into Corwin
Corporation for the duration of the project. Peters Company informed Corwin that Patrick Ray would be the in-house representative, reporting to Delia, and would assume his responsibilities on or about February 15.
By the time Pat Ray appeared at Corwin Corporation, West had completed the first three tests. The results were not what was expected, but gave promise that Corwin was heading in the right direction. Pat Ray’s interpretation of the tests was completely opposite to that of West. Ray thought that Corwin was “way off base,” and that redirection was needed.
Pat Ray: “Look, Dan! We have only six months to do this effort and we shouldn’t waste our time on marginally acceptable data. These are the next five tests I’d like to see performed.”
Dan West: “Let me look over your request and review it with my people. That will take a couple of days, and, in the meanwhile, I’m going to run the other two tests as planned.”
Ray’s arrogant attitude bothered West. However, West decided that the project was too important to “knock heads” with Ray and simply decided to cater to Ray the best he could. This was not exactly the working relationship that West expected to have with the in-house representative.
West reviewed the test data and the new test matrix with engineering personnel, who felt that the test data was inconclusive as yet and preferred to withhold their opinion until the results of the fourth and fifth tests were made available. Although this displeased Ray, he agreed to wait a few more days if it meant getting Corwin Corporation on the right track.
The fourth and fifth tests appeared to be marginally acceptable just as the first three had been. Corwin’s engineering people analyzed the data and made their recommendations.
West: “Pat, my people feel that we’re going in the right direction and that our path has greater promise than your test matrix.”
Ray: “As long as we’re paying the bills, we’re going to have a say in what tests are conducted. Your proposal stated that we would work together in developing the other test conditions. Let’s go with my test matrix. I’ve already reported back to my boss that the first five tests were failures and that we’re changing the direction of the project.”
West: “I’ve already purchased $30,000 worth of raw materials. Your matrix uses other materials and will require additional expenditures of $12,000.”
Ray: “That’s your problem. Perhaps you shouldn’t have purchased all of the raw materials until we agreed on the complete test matrix.”
During the month of February, West conducted 15 tests, all under Ray’s direction. The tests were scattered over such a wide range that no valid conclusions could be drawn. Ray continued sending reports back to Delia confirming that Corwin was not producing beneficial results and there was no indication that the situation would reverse itself. Delia ordered Ray to take any steps necessary to ensure a successful completion of the project.
Ray and West met again as they had done for each of the past 45 days to discuss the status and direction of the project.
Ray: “Dan, my boss is putting tremendous pressure on me for results, and thus far I’ve given him nothing. I’m up for promotion in a couple of months and I can’t let this project stand in my way. It’s time to completely redirect the project.”
West: “Your redirection of the activities is playing havoc with my scheduling. I have people in other departments who just cannot commit to this continual rescheduling. They blame me for not communicating with them when, in fact, I’m embarrassed to.”
Ray: “Everybody has their problems. We’ll get this problem solved. I spent this morning working with some of your lab people in designing the next 15 tests. Here are the test conditions.”
West: “I certainly would have liked to be involved with this. After all, I thought I was the project manager. Shouldn’t I have been at the meeting?”
Ray: “Look, Dan! I really like you, but I’m not sure that you can handle this project. We need some good results immediately, or my neck will be stuck out for the next four months. I don’t want that. Just have your lab personnel start on these tests, and we’ll get along fine. Also, I’m planning on spending a great deal of time in your lab area. I want to observe the testing personally and talk to your lab personnel.”
West: “We’ve already conducted 20 tests, and you’re scheduling another 15 tests.
I priced out only 30 tests in the proposal. We’re heading for a cost overrun condition.”
Ray: “Our contract is a firm-fixed-price effort. Therefore, the cost overrun is your problem.”
West met with Dr. Reddy to discuss the new direction of the project and potential cost overruns. West brought along a memo projecting the costs through the end of the third month of the project (see Exhibit III).
Exhibit III. Projected cost summary at the end of the third month
Original Proposal Cost
Total Project Costs
Summary for Six-
Projected at End of
60,000 (30 tests)
70,000 (35 tests)
*Total engineering overhead was estimated at 100 percent, whereas the R&D overhead was 120 percent.
Reddy: “I’m already overburdened on other projects and won’t be able to help you out. Royce picked you to be the project manager because he felt that you could do the job. Now, don’t let him down. Send me a brief memo next month explaining the situation, and I’ll see what I can do. Perhaps the situation will correct itself.”
During the month of March, the third month of the project, West received almost daily phone calls from the people in the lab stating that Pat Ray was interfering with their job. In fact, one phone call stated that Ray had changed the test conditions from what was agreed on in the latest test matrix. When West confronted Ray on his meddling, Ray asserted that Corwin personnel were very unprofessional in their attitude and that he thought this was being carried down to the testing as well. Furthermore, Ray demanded that one of the functional employees be removed immediately from the project because of incompetence. West stated that he would talk to the employee’s department manager. Ray, however, felt that this would be useless and said, “Remove him or else!” The functional employee was removed from the project.
By the end of the third month, most Corwin employees were becoming disenchanted with the project and were looking for other assignments. West attributed this to Ray’s harassment of the employees. To aggravate the situation even further, Ray met with Royce and Reddy, and demanded that West be removed and a new project manager be assigned.
Royce refused to remove West as project manager, and ordered Reddy to take charge and help West get the project back on track.
Reddy: “You’ve kept me in the dark concerning this project, West. If you want me to help you, as Royce requested, I’ll need all the information tomorrow, especially the cost data. I’ll expect you in my office tomorrow morning at 8:00 A.M.
I’ll bail you out of this mess.”
West prepared the projected cost data for the remainder of the work and presented the results to Dr. Reddy (see Exhibit IV). Both West and Reddy agreed that the project was now out of control, and severe measures would be required to correct the situation, in addition to more than $250,000 in corporate funding.
Reddy: “Dan, I’ve called a meeting for 10:00 A.M. with several of our R&D people to completely construct a new test matrix. This is what we should have done right from the start.”
West: “Shouldn’t we invite Ray to attend this meeting? I’m sure he’d want to be involved in designing the new test matrix.”
Reddy: “I’m running this show now, not Ray!! Tell Ray that I’m instituting new policies and procedures for in-house representatives. He’s no longer authorized to visit the labs at his own discretion. He must be accompanied by either you or me. If he doesn’t like these rules, he can get out. I’m not going to allow that guy to disrupt our organization. We’re spending our money now, not his.”
West met with Ray and informed him of the new test matrix as well as the new policies and procedures for in-house representatives. Ray was furious over the new turn of events and stated that he was returning to Peters Company for a meeting with Delia.
On the following Monday, Frimel received a letter from Delia stating that Peters Company was officially canceling the contract. The reasons given by Delia were as follows:
Exhibit IV. Estimate of total project completion costs
Direct labor/support $ 47,000*
Testing (60 tests) 120,000*
Overhead (120%) 200,000*
Materials 103,000* G&A 47,000*
Peters contract 250,000*
*Includes Dr. Reddy.
Royce and Frimel met to decide on a course of action in order to sustain good working relations with Peters Company. Frimel wrote a strong letter refuting all of the accusations in the Peters letter, but to no avail. Even the fact that Corwin was willing to spend $250,000 of their own funds had no bearing on Delia’s decision. The damage was done. Frimel was now thoroughly convinced that a contract should not be accepted on “Pearl Harbor Day.”
In June of 1998, the executive committee of Quantum Telecom reluctantly approved two R&D projects that required technical breakthroughs. To make matters worse, the two products had to be developed by the summer of 1999 and introduced into the marketplace quickly. The life expectancy of both products was estimated to be less than one year because of the rate of change in technology. Yet, despite these risks, the two projects were fully funded. Two senior executives were assigned as the project sponsors, one for each project.
Quantum Telecom had a world-class project management methodology with five life cycle phases and five gate review meetings. The gate review meetings were go/no-go decision points based upon present performance and future risks. Each sponsor was authorized and empowered to make any and all decisions relative to projects, including termination.
Company politics always played an active role in decisions to terminate a project. Termination of a project often impacted the executive sponsor’s advancement opportunities because the projects were promoted by the sponsors and funded through the sponsor’s organization.
During the first two gate review meetings, virtually everyone recommended the termination of both projects. Technical breakthroughs seemed unlikely, and the schedule appeared unduely optimistic. But terminating the projects this early would certainly not reflect favorably upon the sponsors. Reluctantly, both sponsors agreed to continue the projects to the third gate in hopes of a “miracle.”
During the third gate review, the projects were still in peril. Although the technical breakthrough opportunity now seemed plausible, the launch date would have to be slipped, thus giving Quantum Telecom a window of only six months to sell the products before obsolescence would occur.
By the fourth gate review, the technical breakthrough had not yet occurred but did still seem plausible. Both project managers were still advocating the cancellation of the projects, and the situation was getting worse. Yet, in order to “save face” within the corporation, both sponsors allowed the projects to continue to completion. They asserted that, “If the new products could not be sold in sufficient quantity to recover the R&D costs, then the fault lies with marketing and sales, not with us.” The sponsors were now off the hook, so to speak.
Both projects were completed six months late. The salesforce could not sell as much as one unit, and obsolescence occurred quickly. Marketing and sales were blamed for the failures, not the project sponsors.
The ill-fated Trophy Project was in trouble right from the start. Reichart, who had been an assistant project manager, was involved with the project from its conception. When the Trophy Project was accepted by the company, Reichart was assigned as the project manager. The program schedules started to slip from day one, and expenditures were excessive. Reichart found that the functional managers were charging direct labor time to his project but working on their own pet projects. When Reichart complained of this, he was told not to meddle in the functional manager’s allocation of resources and budgeted expenditures. After approximately six months, Reichart was requested to make a progress report directly to corporate and division staffs.
Reichart took this opportunity to bare his soul. The report substantiated that the project was forecasted to be one complete year behind schedule. Reichart’s staff, as supplied by the line managers, was inadequate to stay at the required pace, let alone make up any time that had already been lost. The estimated cost at completion at this interval showed a cost overrun of at least 20 percent. This was Reichart’s first opportunity to tell his story to people who were in a position to correct the situation. The result of Reichart’s frank, candid evaluation of the Trophy Project was very predictable. Nonbelievers finally saw the light, and the line managers realized that they had a role to play in the completion of the project. Most of the problems were now out in the open and could be corrected by providing adequate staffing and resources. Corporate staff ordered immediate remedial action and staff support to provide Reichart a chance to bail out his program.
The results were not at all what Reichart had expected. He no longer reported to the project office; he now reported directly to the operations manager. Corporate staff’s interest in the project became very intense, requiring a 7:00 A.M. meeting every Monday morning for complete review of the project status and plans for recovery. Reichart found himself spending more time preparing paperwork, reports, and projections for his Monday morning meetings than he did administering the Trophy Project. The main concern of corporate was to get the project back on schedule. Reichart spent many hours preparing the recovery plan and establishing manpower requirements to bring the program back onto the original schedule.
Group staff, in order to closely track the progress of the Trophy Project, assigned an assistant program manager. The assistant program manager determined that a sure cure for the Trophy Project would be to computerize the various problems and track the progress through a very complex computer program. Corporate provided Reichart with twelve additional staff members to work on the computer program. In the meantime, nothing changed. The functional managers still did not provide adequate staff for recovery, assuming that the additional manpower Reichart had received from corporate would accomplish that task.
After approximately $50,000 was spent on the computer program to track the problems, it was found that the program objectives could not be handled by the computer. Reichart discussed this problem with a computer supplier and found that $15,000 more was required for programming and additional storage capacity. It would take two months for installation of the additional storage capacity and the completion of the programming. At this point, the decision was made to abandon the computer program.
Reichart was now a year and a half into the program with no prototype units completed. The program was still nine months behind schedule with the overrun projected at 40 percent of budget. The customer had been receiving his reports on a timely basis and was well aware of the fact that the Trophy Project was behind schedule. Reichart had spent a great deal of time with the customer explaining the problems and the plan for recovery. Another problem that Reichart had to contend with was that the vendors who were supplying components for the project were also running behind schedule.
One Sunday morning, while Reichart was in his office putting together a report for the client, a corporate vice president came into his office. “Reichart,” he said, “in any project I look at the top sheet of paper and the man whose name appears at the top of the sheet is the one I hold responsible. For this project your name appears at the top of the sheet. If you cannot bail this thing out, you are in serious trouble in this corporation.” Reichart did not know which way to turn or what to say. He had no control over the functional managers who were creating the problems, but he was the person who was being held responsible.
After another three months the customer, becoming impatient, realized that the Trophy Project was in serious trouble and requested that the division general manager and his entire staff visit the customer’s plant to give a progress and “get well” report within a week. The division general manager called Reichart into his office and said, “Reichart, go visit our customer. Take three or four functional line people with you and try to placate him with whatever you feel is necessary.” Reichart and four functional line people visited the customer and gave a four-anda-half-hour presentation defining the problems and the progress to that point. The customer was very polite and even commented that it was an excellent presentation, but the content was totally unacceptable. The program was still six to eight months late, and the customer demanded progress reports on a weekly basis. The customer made arrangements to assign a representative in Reichart’s department to be “on-site” at the project on a daily basis and to interface with Reichart and his staff as required. After this turn of events, the program became very hectic.
The customer representative demanded constant updates and problem identification and then became involved in attempting to solve these problems. This involvement created many changes in the program and the product in order to eliminate some of the problems. Reichart had trouble with the customer and did not agree with the changes in the program. He expressed his disagreement vocally when, in many cases, the customer felt the changes were at no cost. This caused a deterioration of the relationship between client and producer.
One morning Reichart was called into the division general manager’s office and introduced to Mr. “Red” Baron. Reichart was told to turn over the reins of the Trophy Project to Red immediately. “Reichart, you will be temporarily reassigned to some other division within the corporation. I suggest you start looking outside the company for another job.” Reichart looked at Red and asked, “Who did this? Who shot me down?”
Red was program manager on the Trophy Project for approximately six months, after which, by mutual agreement, he was replaced by a third project manager. The customer reassigned his local program manager to another project. With the new team the Trophy Project was finally completed one year behind schedule and at a 40 percent cost overrun.
The Concrete Masonry Corporation (CMC), after being a leader in the industry for over twenty-five years, decided to get out of the prestressed concrete business. Although there had been a boom in residential construction in recent years, commercial work was on the decline. As a result, all the prestressed concrete manufacturers were going farther afield to big jobs. In order to survive, CMC was forced to bid on jobs previously thought to be out of their geographical area. Survival depended upon staying competitive.
In 1975, the average selling price of a cubic foot of concrete was $8.35, and in 1977, the average selling price had declined to $6.85. As CMC was producing at a rate of a million cubic feet a year, not much mathematics was needed to calculate they were receiving one-and-a-half million dollars per year less than they had received a short two years before for the same product.
Product management was used by CMC in a matrix organizational form. CMC’s project manager had total responsibility from the design to the completion of the construction project. However, with the declining conditions of the market and the evolution that had drastically changed the character of the marketplace, CMC’s previously successful approach was in question.
History—The Prestressed Concrete Business
HISTORY—THE CONCRETE BLOCK BUSINESS
CMC started in the concrete block business in 1946. At the beginning, CMC became a leader in the marketplace for two reasons: (1) advanced technology of manufacturing and (2) an innovative delivery system. With modern equipment, specifically the flat pallet block machine, CMC was able to make different shapes of block without having to make major changes in the machinery. This change, along with the pioneering of the self-unloading boom truck, which permitted efficient, cost-saving delivery, contributed to the success of CMC’s block business. Consequently, the block business success provided the capital needed for CMC to enter the prestressed concrete business.
HISTORY—THE PRESTRESSED CONCRETE BUSINESS
Prestressed concrete is made by casting concrete around steel cables that are stretched by hydraulic jacks. After the concrete hardens, the cables are releasd, thus compressing the concrete. Concrete is strongest when it is compressed. Steel is strongest when it is stretched, or in tension. In this way, CMC combined the two strongest qualities of the two materials. The effectiveness of the technique can be readily demonstrated by lifting a horizontal row of books by applying pressure at each end of the row at a point below the center of gravity.
Originally, the concrete block manufacturing business was a natural base from which to enter the prestressed concrete business because the very first prestressed concrete beams were made of a row of concrete block, prestressed by using high tension strength wires through the cores of the block. The wire was pulled at a high tension, and the ends of the beams were grouted. After the grout held the wires or cables in place, the tension was released on the cables, with resultant compression on the bottom portion of the beams. Thus the force on the bottom of the beam would tend to counteract the downward weight put on the top of the beam. By this process, these prestressed concrete beams could cover three to four times the spans possible with conventional reinforced concrete.
In 1951, after many trips to Washington, DC, and an excellent selling job by CMC’s founder, T. L. Goudvis, CMC was able to land their first large-volume prestressed concrete project with the Corps of Engineers. The contract authorized the use of prestressed concrete beams, as described, with concrete block for the roofs of warehouses in the large Air Force depot complex being built in Shelby, Ohio. The buildings were a success, and CMC immediately received prestige and notoriety as a leader in the prestressed concrete business.
Wet-cast beams were developed next. For wet-cast beams, instead of concrete block, the cables were placed in long forms and pulled to the desired tension, after which concrete was poured in the forms to make beams. As a result of wetcast beams, prestressed concrete was no longer dependent on concrete block.
At first, prestressed concrete was primarily for floors and roofs, but, in the early 1960s, precasters became involved in more complicated structures. CMC started designing and making not only beams, but columns and whatever other components it took to put together a whole structure. Parking garages became a natural application for prestressed concrete structures. Eventually an entire building could be precast out of prestressed concrete.
Constructing the entire building, as in the case of a parking garage, meant that jobs were becoming more complex with respect to interdependence of detailed task accomplishment. Accordingly, in 1967, project management was established at CMC. The functional departments did the work, but the project managers saw to it that the assigned projects were completed on schedule and within budget and specifications. A matrix organization, as illustrated in Exhibit I, was adopted and used effectively by CMC. The concept of a matrix organization, as applied at CMC, entailed an organizational system designed as “web of relationships” rather than a line and staff relationship for work performance.
Each project manager was assigned a number of personnel with the required qualification from the functional departments for the duration of the project. Thus the project organization was composed of the project manager and functional personnel groups. The project manager had not only the responsibility and accountability for the successful completion of the contract, but also the delegated authority for work design, assignments of functional group personnel, and the determination of procedural relationships.
The most important functional area for the project manager was the engineering department, since prestressed concrete is a highly engineered product. A great deal of coordination and interaction was required between the project manager and the engineering department just to make certain that everything fit together and was structurally sound. A registered engineer did the design. The project manager’s job was to see that the designing was done correctly and efficiently. Production schedules were made up by the project manager subject, of course, to minor modifications by the plant. The project manager was also required to do all the coordination with the customer, architect, general contractor, and the erection force. The project manager was also required to have interaction with the distribution manager to be certain that the product designed could be shipped by trucks. Finally, there had to be interaction between the project manager and the sales department to determine that the product the project manager was making was what the sales department had sold.
Exhibit I. Matrix organization of Concrete Masonry Corporation
At one time or another during CMC’s history, the estimating function had been assigned to nearly every functional area of the organization, including sales, engineering, manufacturing, and administration. Determining which functional area estimating was to be under was a real problem for CMC. There was a short time when estimating was on its own, reporting directly to the general manager.
Assignment of this function to any one department carried with it some inherent problems, not peculiar to CMC, but simply related to human nature. For example, when the estimating was supervised in the sales department, estimated costs would tend to be low. In sales, the estimator knows the boss wants to be the low bidder on the job and therefore believes he or she is right to say, “It is not going to take us ten days to cast this thing; we could run three at a time.”
When estimating was performed by production, the estimate would tend to be high. This was so because the estimator did not want the boss, the production manager, coming back and saying, “How come you estimated this thing at $5 a cubic foot and it’s costing us $6? It’s not the cost of production that’s wrong, it’s the estimate.”
It is very difficult to get accountability for estimating a project. When many of your projects are new ballgames, a lot of your information has to come from . . . well, let’s just say there is a lot of art to it as well as science. You never can say with 100 percent certainty that costs were high because you could have just as easily said the estimate was too low.
So, as a compromise, most of the time we had our estimating done by engineering. While it solved some problems, it also created others. Engineers would tend to be more fair; they would call the shots as they saw them. However, one problem was that they still had to answer to sales as far as their workload was concerned. For example, an engineer is in the middle of estimating a parking garage, a task that might take several days. All of a sudden, the sales department wants him to stop and estimate another job. The sales department had to be the one to really make that decision because they are the ones that know what the priorities are on the bidding. So even though the estimator was working in engineering, he was really answering to the sales manager as far as his workload was concerned.
Estimating was accomplished through continual monitoring and comparison of actual versus planned performance, as shown in Exhibit II.
The actual costing process was not a problem for CMC. In recent years, CMC had eliminated as much as possible the actual dollars and cents from the estimator’s control. A great deal of the “drudge work” was done on the computer. The estimator, for example, would predict how much the prestressed concrete
Exhibit II. Actual versus planned performance
must span, and how many cubic feet of concrete was needed. Once that information was in hand, the estimator entered it in the computer. The computer would then come up with the cost. This became an effective method because the estimator would not be influenced by either sales or production personnel.
THE EVOLUTION OF THE PRESTRESSED
During the twenty or more years since prestressing achieved wide acceptance in the construction industry, an evolution has been taking place that has drastically changed the character of the marketplace and thus greatly modified the role of the prestresser.
Lasch had the following comments about these changes that occurred in the marketplace:
In the early days, designers of buildings looked to prestressers for the expertise required to successfully incorporate the techniques and available prestressed products into their structures. A major thrust of our business in those days was to introduce design professionals, architects, and engineers to our fledgling industry and to assist them in making use of the many advantages that we could offer over other construction methods. These advantages included fire resistance, long spans, permanence, factory-controlled quality, speed of erection, aesthetic desirability, virtual elimination of maintenance costs, and, last but of prime importance, the fact that we were equipped to provide the expertise and coordination necessary to successfully integrate our product into the building. Many of our early jobs were bid from sketches. It was then up to our in-house experts, working closely with the owner’s engineer and architect, to develop an appropriate, efficient structure that satisfied the aesthetic and functional requirements and hopefully maximized production and erection efficiency, thereby providing maximum financial return to CMC. It should be noted that, although our contract was normally with the project’s general contractor, most of our design coordination was through the owner’s architect or engineer and, more often than not, it was our relationship with the owner and his design professional that determined our involvement in the project in the first place. It should be readily seen that, in such an environment, only organizations with a high degree of engineering background and a well-organized efficient team of professionals, could compete successfully. CMC was such an organization.
There are, however, few, if any, proprietary secrets in the prestressing industry, and it was inevitable that this would in later years be largely responsible for a dramatic change in the marketplace. The widespread acceptance of the product, which had been achieved through the success of companies like
CMC, carried with it a proliferation of the technical knowledge and production techniques which design professionals had previously relied upon the producer to provide. In the later 1960s, some colleges and universities began to include prestressed concrete design as a part of their structural engineering programs. Organizations, such as the Portland Cement Association, offered seminars for architects and engineers to promote the prestressing concept. As a result, it is now common for architects and engineers to incorporate prestressed concrete products in bid drawings for their projects, detailing all connections, reinforcement, mix designs, and so on. This, obviously, makes it possible for any organization capable of reading drawings and filling forms to bid on the project. We have found ourselves bidding against companies with a few molds in an open field and, in several cases, a broker with no equipment or organization at all! The result of all this, of course, is a market price so low as to prohibit the involvement of professional prestressing firms with the depth of organization described earlier.
OBTAINING A PRESTRESSED CONCRETE JOB
The author believes the following example demonstrates the change in market conditions and best illustrates one of the reasons CMC decided not to remain in the prestressed concrete business. A large insurance company in Columbus, Ohio, was planning a parking garage for 2,500 cars. CMC talked to the owner and owner’s representative (a construction management firm) about using prestressed concrete in the design of their project rather than the poured-in-place concrete, steel, or whatever options they had. Just by doing this, CMC had to give away some knowledge. You just cannot walk in and say, “Hey, how about using prestressed concrete?” You have to tell them what is going to be saved and how, because the architect has to make the drawings. Once CMC felt there was an open door, and that the architect and owner would possibly incorporate their product, then sales would consult engineering to come up with a proposal. A proposal in the early stages was simply to identify what the costs were going to be, and to show the owner and architect photographs or sketches of previous jobs. As time went by, CMC had to go into more detail and provide more and more information, including detailed drawings of several proposed layouts. CMC illustrated connection details, reinforcing details, and even computer design of some of the pieces for the parking garage. Receiving all this engineering information, the owner and the construction management firm became convinced that using this product was the most inexpensive way for them to go. In fact, CMC demonstrated to the insurance company that they could save over $1 million over any other product. At this point, CMC had spent thousands of dollars to come up with the solution for the problem of designing the parking garage.
Months and years passed until the contract manager chose to seek bids from other precasters, who, up to this time, had little or no investment in the project. CMC had made available an abundance of free information that could be used by Synopsis
the competition. The competition only had to put the information together, make a material takeoff, calculate the cost, and put a price on it. Without the costly depth of organization required to support the extensive promotional program conducted by CMC, the competition could naturally bid the job lower.
Lasch felt that, as a result of present-day market conditions, there were only two ways that one survives in the prestressed concrete business:
Face the fact that you are going to be subservient to a general contractor and that you are going to sell not your expertise but your function as a ‘job shop’ manufacturer producing concrete products according to someone else’s drawings and specifications. If you do that, then you no longer need, for example, an engineering department or a technically qualified sales organization. All you are going to do is look at drawings, have an estimator who can read the drawings, put a price tag on them, and give a bid. It is going to be a low bid because you have eliminated much of your overhead. We simply do not choose to be in business in this manner.
The other way to be in the business is that you are not going to be subservient to a general contractor, or owner’s architect, or engineer. What you are going to do is to deal with owners or users. That way a general contractor may end up as a subcontractor to the prestresser. We might go out and build a parking garage or other structure and assume the role of developer or builder or even owner/leaser. In that way, we would control the whole job. After all, in most cases the precast contract on a garage represents more than half the total cost. It could be argued with great justification that the conventional approach (i.e., precaster working for general contractor) could be compared to the tail wagging the dog.
With complete control of design, aesthetics, and construction schedule, it would be possible to achieve maximum efficiency of design, plant usage, and field coordination which, when combined, would allow us to achieve that most important requirement—that of providing the eventual user with maximum value for a minimum investment. Unless this can be achieved, the venture would not be making a meaningful contribution to society, and there would be no justification for being in business.
Concrete Masonry Corporation’s (CMC) difficulties do not arise from the fact that the organization employs a matrix structure, but rather from the failure of the corporation’s top management to recognize, in due time, the changing nature (with respect to the learning curve of the competition and user of the product and services of CMC) of the prestressed concrete business.
At the point in time when prestressed concrete gained wide industry acceptance, and technical schools and societies began offering courses in the techniques for utilizing this process, CMC should have begun reorganizing its prestressed concrete business activities in two separate functional costing groups. Marketing and selling CMC’s prestressed concrete business services and utilizing the company’s experience, technical expertise, judgment, and job estimating abilities should satisfy the responsibilities of one of these groups, to perform the actual prestressed concrete engineering and implementation of the other.
With the responsibilities and functions separated as noted above, the company is able to determine more precisely how competitive they really are and which (if either) phase of the concrete business to divest themselves of.
Project management activities are best performed when complex tasks are of a limited life. Such is not the case in securing new or continuing business in the prestressed concrete business but rather is an effort or activity that should continue as long as CMC is in the business. This phase of the business should therefore be assigned to a functional group. However, it may be advantageous at times to form or utilize a project management structure in order to assist the functional group in satisfying a task’s requirements when the size of the task is large and complex.
The engineering and implementation phase of the business should continue to be performed through the project management–matrix structure because of the limited life of such tasks and the need for concentrated attention to time, cost, and performance constraints inherent in these activities.
“I’ve called this meeting, gentlemen, because that paper factory we call a computer organization is driving up our overhead rates,” snorted Richard Margo, president, as he looked around the table at the vice presidents of project management, engineering, manufacturing, marketing, administration, and information systems. “We seem to be developing reports faster than we can update our computer facility. Just one year ago, we updated our computer and now we’re operating three shifts a day, seven days a week. Where do we go from here?”
V.P. information: “As you all know, Richard asked me, about two months ago, to investigate this gigantic increase in the flow of paperwork. There’s no question that we’re getting too many reports. The question is, are we paying too much money for the information that we get? I’ve surveyed all of our departments and their key personnel. Most of the survey questionnaires indicate that we’re getting too much information. Only a small percentage of each report appears to be necessary. In addition, many of the reports arrive too late. I’m talking about scheduled reports, not planning, demand, or exception reports.”
V.P. project management: “Every report people may receive is necessary for us to make decisions effectively with regard to planning, organizing, and controlling each project. My people are the biggest users and we can’t live with fewer reports.”
V.P. information: “Can your people live with less information in each report? Can some of the reports be received less frequently?”
V.P. project management: “Some of our reports have too much information in them. But we need them at the frequency we have now.”
V.P. engineering: “My people utilize about 20 percent of the information in most of our reports. Once our people find the information they want, the report is discarded. That’s because we know that each project manager will retain a copy. Also, only the department managers and section supervisors read the reports.”
V.P. information: “Can engineering and manufacturing get the information they need from other sources, such as the project office?”
V.P. project management: “Wait a minute! My people don’t have time to act as paper pushers for each department manager. We all know that the departments can’t function without these reports. Why should we assume the burden?”
V.P. information: “All I’m trying to say is that many of our reports can be combined into smaller ones and possibly made more concise. Most of our reports are flexible enough to meet changes in our operating business. We have two sets of reports: one for the customer and one for us. If the customer wants the report in a specific fashion, he pays for it. Why can’t we act as our own customer and try to make a reporting system that we can all use?”
V.P. engineering: “Many of the reports obviously don’t justify the cost. Can we generate the minimum number of reports and pass it on to someone higher or lower in the organization?”
V.P. project management: “We need weekly reports, and we need them on Monday mornings. I know our computer people don’t like to work on Sunday evenings, but we have no choice. If we don’t have those reports on Monday mornings, we can’t control time, cost, and performance.”
V.P. information: “There are no reports generated from the pertinent data in our original computer runs. This looks to me like every report is a one-shot deal. There has to be room for improvement.
“I have prepared a checklist for each of you with four major questions. Do you want summary or detailed information? How do you want the output to look? How many copies do you need? How often do you need these reports?”
Richard Margo: “In project organizational forms, the project exists as a separate entity except for administrative purposes. These reports are part of that administrative purpose. Combining this with the high cost of administration in our project structure, we’ll never remain competitive unless we lower our overhead. I’m going to leave it up to you guys. Try to reduce the number of reports, but don’t sacrifice the necessary information you need to control the projects and your resources.”
The Green Company production project was completed three months behind schedule and at a cost overrun of approximately 60 percent. Following submittal of the final report, Phil Graham, the director of project management, called a meeting to discuss the problems encountered on the Green Project.
Phil Graham: “We’re not here to point the finger at anyone. We’re here to analyze what went wrong and to see if we can develop any policies and/or procedures that will prevent this from happening in the future. What went wrong?”
Project manager: “When we accepted the contract, Green did not have a fixed delivery schedule for us to go by because they weren’t sure when their new production plant would be ready to begin production activities. So, we estimated 3,000 units per month for months five through twelve of the project. When they found that the production plant would be available two months ahead of schedule, they asked us to accelerate our production activities. So, we put all of our production people on overtime in order to satisfy their schedule. This was our mistake, because we accepted a fixed delivery date and budget before we understood everything.”
Functional manager: “Our problem was that the customer could not provide us with a fixed set of specifications, because the final set of specifications depended on OSHA and EPA requirements, which could not be confirmed until initial testing of the new plant. Our people, therefore, were asked to commit to manhours before specifications could be reviewed.
“Six months after project go-ahead, Green Company issued the final specifications. We had to remake 6,000 production units because they did not live up to the new specifications.”
Project manager: “The customer was willing to pay for the remake units. This was established in the contract. Unfortunately, our contract people didn’t tell me that we were still liable for the penalty payments if we didn’t adhere to the original schedule.”
Phil Graham: “Don’t you feel that misinterpretation of the terms and conditions is your responsibility?”
Project manager: “I guess I’ll have to take some of the blame.”
Functional manager: “We need specific documentation on what to do in case of specification changes. I don’t think that our people realize that user approval of specification is not a contract agreed to in blood. Specifications can change, even in the middle of a project. Our people must understand that, as well as the necessary procedures for implementing change.”
Phil Graham: “I’ve heard that the functional employees on the assembly line are grumbling about the Green Project. What’s their gripe?”
Functional manager: “We were directed to cut out all overtime on all projects. But when the Green Project got into trouble, overtime became a way of life. For nine months, the functional employees on the Green Project had as much overtime as they wanted. This made the functional employees on other projects very unhappy.
“To make matters worse, the functional employees got used to a big takehome paycheck and started living beyond their means. When the project ended, so did their overtime. Now, they claim that we should give them the opportunity for more overtime. Everybody hates us.”
Phil Graham: “Well, now we know the causes of the problem. Any recommendations for cures and future prevention activities?”
The Automated Evaluation Project
“No deal!” said the union. “The current method of evaluating government employees at this agency is terrible, and if a change doesn’t occur, we’ll be in court seeking damages.”
In 1984, a government agency approved and initiated an ambitious project, part of which was to develop an updated, automated evaluation system for the 50,000 employees located throughout the United States. The existing evaluation system was antiquated. Although there were forms used for employee evaluation, standardization was still lacking. Not all promotions were based on performance. Often, it was based on time in grade, the personal whims of management, or friendships. Some divisions seemed to promote employees faster than others. The success or failure of a project could also seriously impact performance opportunities. Some type of standardization was essential.
In June 1985, a project manager was finally assigned and brought on board. The assignment of the project manager was based upon rank and availability at that time rather than the requirements of the project. Team members often possessed a much better understanding of the project than did the project manager.
1Copyright © 2005 by Harold Kerzner. This case study is fictitious and was prepared as the basis for classroom discussion rather than to illustrate an effective or ineffective handling of an administrative situation.
The project manager, together with his team, quickly developed an action plan. The action plan did not contain a work breakdown structure, but did contain a statement of work which called out high-level deliverables that would be essential for structured analyses, design and programming. The statement of work and deliverables were more so in compliance with agency requirements for structured analyses, design, and programming than for the project’s requirement. The entire action plan was prepared by the project office, which was composed of eight employees.
Bids from outside vendors were solicited for the software packages, with the constraint that all deliverables must be operational on existing agency hardware. In October 1985, the award was made by the project office to Primco Corporation with work scheduled to begin in December 1985.
In the spring of 1986, it became apparent that the project was running into trouble and disaster was imminent. There were three major problems facing the project manager. As stated by the project manager:
The last item was argumentative. The line managers at the agency contended that they had assigned some of their best people and that the real problem was that the project manager was trying to make all of the decisions himself without any input from the assigned personnel. The employees contended that proper project management practices were not being used. The project was being run like a dictatorship rather than a democracy. Several employees felt as though they were not treated as part of the project team.
According to one of the team members,
The project manager keeps making technical decisions without any solid foundation to support his views. Several of us in the line organization have significantly more knowledge than does the project manager, yet he keeps overriding our recommendations and decisions. Perhaps he has that right, but I dislike being treated as a second-class citizen. If the project manager has all of this technical knowledge, then why does he need us?
In June 1986, the decision was made by the project manager to ask one of the assistant agency directors to tell the union that the original commitment date of January 1987 would not be met. A stop workage order was issued to Primco, thus canceling the contract.
The original action plan called for the use of existing agency hardware. However, because of unfavorable publicity about hardware and software problems at the agency during the spring of 1986, the agency felt that the UNIVAC System would not support the additional requirements, and system overload might occur. Now hardware, as well as software, would be needed.
To help maintain morale, the project manager decided to perform as much of the work as possible in-house, even though the project lacked critical resources and was already more than one year late. The project office took what was developed thus far and tried to redefine the requirements.
With the support of senior management at the agency, the original statement of work was thrown away and a new statement of work was prepared. “It was like starting over right from the beginning,” remarked one of the employees. “We never looked back at what was accomplished thus far. It was a whole new project!” With the support of the agency’s personnel office, the new requirements were finally completed in February of 1987.
The union, furious over the schedule slippage, refused to communicate with the project office and senior management. The union’s contention was that an “illegal” evaluation system was in place, and the current system could not properly validate performance review requirements. The union initiated a lawsuit against the agency seeking damages in excess of $21 million.
In November 1986, procurement went out for bids for both hardware and a database management system. The procurement process continued until June 1987, when it was canceled by another government agency responsible for procurement. No reason was ever provided for the cancellation.
Seeking alternatives, the following decisions were made:
The database management system was actually in the final stages of development and ITEKO Corporation promised the agency that a fully operational version, with the necessary customization, could be provided quickly. Difficulties arose with the use of the ITEKO package. After hiring a consultant from ITEKO, it was found that the ITEKO package was a beta rather than a production version. Despite these setbacks, personnel kept programming on the leased equipment with the hope of eventually purchasing a Micronet Hardware System. ITEKO convinced the agency that the Micronet hardware system was the best system available to support the database management system. The Micronet hardware
THE AUTOMATED EVALUATION PROJECT
was then added to the agency’s equipment contract but later disallowed on September 29, 1987, because it was not standard agency equipment.
On October 10, 1987, the project office decided to outsource some of the work using a small/minority business procurement strategy for hardware to support the ITEKO package. The final award was made in November 1987, subject to software certification by the one of the agency’s logistics centers. Installation in all of the centers was completed between November and December 1987.
The Rise, Fall, and Resurrection of Iridium: A Project Management Perspective
The Iridium Project was designed to create a worldwide wireless handheld mobile phone system with the ability to communicate anywhere in the world at any time. Executives at Motorola regarded the project as the eighth wonder of the world. But more than a decade later and after investing billions of dollars, Iridium had solved a problem that very few customers needed solved. What went wrong? How did the Iridium Project transform from a leading-edge technical marvel to a multi-billion-dollar blunder? Could the potential catastrophe have been prevented?
What it looks like now is a multibillion-dollar science project. There are fundamental problems: The handset is big, the service is expensive, and the customers haven’t really been identified.
There was never a business case for Iridium. There was never market demand. The decision to build Iridium wasn’t a rational business decision. It was more of a religious decision. The remarkable thing is that this happened at a big corporation, and that there was not a rational decision-making process in place to pull the plug. Technology for technology’s sake may not be a good business case.”
—Herschel Shosteck, Telecommunication Consultant
Iridium is likely to be some of the most expensive space debris ever.
In 1985, Bary Bertiger, chief engineer in Motorola’s strategic electronics division, and his wife Karen were on a vacation in the Bahamas. Karen tried unsuccessfully to make a cellular telephone call back to her home near the Motorola facility in Chandler, Arizona, to close a real-estate transaction. Unsuccessful, she asked her husband why it would not be possible to create a telephone system that would work anywhere in the world, even in remote locations.
At this time, cell technology was in its infancy but was expected to grow at an astounding rate. AT&T projected as many as 40 million subscribers by 2000. Cell technology was based upon tower-to-tower transmission as shown in Exhibit 1. Each tower or “gateway” ground station reached a limited geographic area or cell and had to be within the satellite’s field of view. Cell phone users likewise had to be near a gateway that would uplink the transmission to a satellite. The satellite would then downlink the signal to another gateway that would connect the transmission to a ground telephone system. This type of communication is often referred to as bent pipe architecture. Physical barriers between the senders/receivers and the gateways, such as mountains, tunnels, and oceans created interference problems and therefore limited service to high-density communities. Simply stated, cell phones couldn’t leave home. And, if they did, there would be additional “roaming” charges. To make matters worse, every country had its own standards, and some cell phones were inoperable when traveling in other countries.
Communications satellites, in use since the 1960s, were typically geostationary satellites that orbited at altitudes of more than 22,300 miles. At this altitude, three geosynchronous satellites and just a few gateways could cover most of the Earth. But satellites at this altitude meant large phones and annoying quarter second voice delays. Comsat’s Planet 1 phone, for example, weighed in at a computer-case-sized 4.5 pounds. Geosynchronous satellites require signals with a great deal of power. Small mobile phones, with a one-watt signal, could not work with satellites positioned at this altitude. Increasing the power output of the mobile phones would damage human tissue. The alternative was therefore to move the satellites closer to Earth such that less power would be needed. This would require significantly more satellites the closer we get to Earth as well as additional gateways. Geosynchronous satellites, which are 100 times further away The Rise, Fall, and Resurrection of Iridium
 © 2007 by Harold Kerzner. Some of the material has been adapted from Sydney Finkelstein and Shade H. Sanford, “Learning from Corporate Mistakes: The Rise and Fall of Iridium,” Organizational Dynamics, vol. 29, no. 2, pp.138–148, 2000. © 2000 by Elsevier Sciences, Inc. Reproduced by permission.
 Stephanie Paterik, “Iridium Alive and Well,” The Arizona Republic, April 27, 2005, p. D5.
 Judith Bird, “Cellular Technology in Telephones,” data processing, vol. 27, no. 8, October 1985, p. 37.
Exhibit 1. Typical satellite communication architecture
from Earth than low-Earth-orbiting (LEO) satellites, could require almost 10,000 times as much power as LEOs, if everything else were the same.
When Bary Bertiger returned to Motorola, he teamed up with Dr. Raymond Leopold and Kenneth Peterson to see if such a worldwide system could be developed while overcoming all of the limitations of existing cell technology. There was also the problem that LEO satellites would be orbiting the Earth rapidly and going through damaging temperature variations—from the heat of the sun to the cold shadow of Earth. The LEO satellites would most likely need to be replaced every 5 years. Numerous alternative terrestrial designs were discussed and abandoned. In 1987 research began on a constellation of LEO satellites moving in polar orbits that could communicate directly with telephone systems on the ground and with one another.
Iridium’s innovation was to use a large constellation of low-orbiting satellites approximately 400–450 miles in altitude. Because Iridium’s satellites were closer to Earth, the phones could be much smaller and the voice delay imperceptible. But there were still major technical design problems. With the existing design, a large number of gateways would be required, thus substantially increasing the cost of the system. As they left work one day in 1988, Dr. Leopold proposed a critical design element. The entire system would be inverted whereby the transmission would go from satellite to satellite until the transmission reached the satellite directly above the person who would be receiving the message. With this approach, only one gateway Earth station would be required to connect mobile-to-landline calls to existing land-based telephone systems. This was considered to be the sought-after solution and was immediately written in outline format on a whiteboard in a security guard’s office. Thus came forth the idea behind a worldwide wireless handheld mobile phone with the ability to communicate anywhere and anytime.
NAMING THE PROJECT “IRIDIUM”
Motorola cellular telephone system engineer, Jim Williams, from the Motorola facility near Chicago, suggested the name, Iridium. The proposed 77-satellite constellation reminded him of the electrons that encircle the nucleus in the classical Bohr model of the atom. When he consulted the periodic table of the elements to discover which atom had 77 electrons, he found iridium—a creative name that had a nice ring. Fortunately, the system had not yet been scaled back to 66 satellites, or else he might have suggested the name Dysprosium.
OBTAINING EXECUTIVE SUPPORT
Initially, Bertiger’s colleagues and superiors at Motorola had rejected the Iridium concept because of its cost. Originally, the Iridium concept was considered perfect for the U.S. government. Unfortunately, the era of lucrative governmentfunded projects was coming to an end, and it was unlikely that the government would fund a project of this magnitude. However, the idea behind the Iridium concept intrigued Durrell Hillis, the general manager of Motorola’s Space and Technology Group. Hillis believed that Iridium was workable if it could be developed as a commercial system. Hillis instructed Bertiger and his team to continue working on the Iridium concept but to keep it quiet.
“I created a bootleg project with secrecy so no one in the company would know about it,” Hillis recalls. He was worried that if word leaked out, the ferociously competitive business units at Motorola, all of which had to fight for R&D funds, would smother the project with nay-saying.
After 14 months of rewrites on the commercialized business plan, Hillis and the Iridium team leaders presented the idea to Robert Galvin, Motorola’s chairman at the time, who gave approval to go ahead with the project. Robert Galvin, and later his successor and son Christopher Galvin, viewed Iridium as a potential symbol of Motorola’s technological prowess and believed that this would become the eighth wonder in the world. In one of the initial meetings, Robert Galvin turned to John Mitchell, Motorola’s president and chief operating officer, and said, “If you don’t write out a check for this John, I will, out of my own pocket.”7 Launching the Venture
To the engineers at Motorola, the challenge of launching Iridium’s constellation provided considerable motivation. They continued developing the project that resulted in initial service in November 1998 at a total cost of over $5 billion.
LAUNCHING THE VENTURE
On June 26, 1990, Hillis and his team formally announced the launch of the Iridium Project to the general public. The response was not very pleasing to Motorola with skepticism over the fact that this would be a new technology, the target markets were too small, the revenue model was questionable, obtaining licenses to operate in 170 countries could be a problem, and the cost of a phone call might be overpriced. Local phone companies that Motorola assumed would buy into the project viewed Iridium as a potential competitor since the Iridium system bypassed traditional landlines. In many countries, postal, telephone, and telegraph (PTT) operators are state owned and a major source of revenue because of the high profit margins. Another issue was that the Iridium Project was announced before permission was granted by the Federal Communications Commission (FCC) to operate at the desired frequencies.
Both Mitchell and Galvin made it clear that Motorola would not go it alone and absorb the initial financial risk for a hefty price tag of about $3.5 billion. Funds would need to be obtained from public markets and private investors. In order to minimize Motorola’s exposure to financial risk, Iridium would need to be set up as a project-financed company. Project financing involves the establishment of a legally independent project company where the providers of funds are repaid out of cash flow and earnings, and where the assets of the unit (and only the unit) are used as collateral for the loans. Debt repayment would come from the project company only rather than from any other entity. A risk with project financing is that the capital assets may have a limited life. The potential limited life constraint often makes it difficult to get lenders to agree to long-term financial arrangements.
Another critical issue with project financing especially for high-tech projects is that the projects are generally long-term. It would be nearly 8 years before service would begin, and in terms of technology, 8 years is an eternity. The Iridium Project was certainly a “bet on the future.” And if the project were to fail, the company could be worth nothing after liquidation.
In 1991, Motorola established Iridium Limited Liability Corporation (Iridium LLC) as a separate company. In December of 1991, Iridium promoted Leo Mondale to vice president of Iridium International. Financing the project was still a critical issue. Mondale decided that, instead of having just one gateway, there should be as many as 12 regional gateways that plugged into local, groundbased telephone lines. This would make Iridium a truly global project rather than appear as an American-based project designed to seize market share from state-run telephone companies. This would also make it easier to get regulatory approval to operate in 170 countries. Investors would pay $40 million for the right to own their own regional gateway. As stated by Flower:
The motive of the investors is clear: They are taking a chance on owning a slice of a de-facto world monopoly. Each of them will not only have a piece of the company, they will own the Iridium gateways and act as the local distributors in their respective home markets. For them it’s a game worth playing.
There were political ramifications with selling regional gateways. What if in the future the U.S. government forbids shipment of replacement parts to certain gateways? What if sanctions are imposed? What if Iridium were to become a political tool during international diplomacy because of the number of jobs it creates?
In addition to financial incentives, gateway owners were granted seats on the board of directors. As described by David Bennahum, reporter for Wired:
Four times a year, 28 Iridium board members from 17 countries gather to coordinate overall business decisions. They met around the world, shuttling between Moscow, London, Kyoto, Rio de Janeiro, and Rome, surrounded by an entourage of assistants and translators. Resembling a United Nations in miniature, board meetings were conducted with simultaneous translation in Russian, Japanese, Chinese, and English.
The partner with the largest equity share was Motorola. For its contribution of $400 million, Motorola originally received an equity stake of 25 percent, and 6 of the 28 seats on Iridium’s board. Additionally, Motorola made loan guarantees to Iridium of $750 million, with Iridium holding an option for an additional $350 million loan.
For its part, Iridium agreed to $6.6 billion in long-term contracts with Motorola that included $3.4 billion for satellite design and launch and $2.9 billion for operations and maintenance. Iridium also exposed Motorola to developing satellite technology that would provide the latter with significant expertise in building satellite communications systems, as well as vast intellectual property.
THE IRIDIUM SYSTEM
The Iridium system is a satellite-based, wireless personal communications network providing a robust suite of voice features to virtually any destination anywhere on Earth.
The Terrestial and Space-Based Network
The Iridium system comprises three principal components: the satellite network, the ground network, and the Iridium subscriber products including phones and pagers. The design of the Iridium network allows voice and data to be routed virtually anywhere in the world. Voice and data calls are relayed from one satellite to another until they reach the satellite above the Iridium subscriber unit (handset) and the signal is relayed back to Earth.
THE TERRESTIAL AND SPACE-BASED NETWORK
The Iridium constellation consists of 66 operational satellites and 11 spares orbiting in a constellation of 6 polar planes. Each plane has 11 mission satellites performing as nodes in the telephony network. The remaining 11 satellites orbit as spares ready to replace any unserviceable satellite. This constellation ensures that every region on the globe is covered by at least one satellite at all times.
The satellites are in a near-polar orbit at an altitude of 485 miles (780 km). They circle the Earth once every 100 minutes traveling at a rate of 16,832 miles per hour. The satellite weight is 1500 pounds. Each satellite is approximately 40 feet in length and 12 feet in width. In addition, each satellite has 48 spot beams, 30 miles in diameter per beam.
Each satellite is cross-linked to four other satellites; two satellites in the same orbital plane and two in an adjacent plane. The ground network is comprised of the System Control Segment and telephony gateways used to connect into the terrestrial telephone system. The System Control Segment is the central management component for the Iridium system. It provides global operational support and control services for the satellite constellation, delivers satellite-tracking data to the gateways, and performs the termination control function of messaging services. The System Control Segment consists of three main components: four Telemetry Tracking and Control sites, the Operational Support Network, and the Satellite Network Operation Center. The primary linkage between the System Control Segment, the satellites, and the gateways is via K-band feeder links and cross-links throughout the satellite constellation.
Gateways are the terrestrial infrastructure that provides telephony services, messaging, and support to the network operations. The key features of gateways are their support and management of mobile subscribers and the interconnection of the Iridium network to the terrestrial phone system. Gateways also provide network management functions for their own network elements and links.
PROJECT INITIATION: DEVELOPING THE
For the Iridium Project to be a business success rather than just a technical success there had to exist an established customer base. Independent studies conducted by A.T. Kearney, Booz, Allen & Hamilton, and Gallup indicated that 34 million people had a demonstrated need for mobile satellite services, with that number expected to grow to 42 million by 2002. Of these 42 million, Iridium anticipated 4.2 million to be satellite-only subscribers, 15.5 million satellite and world terrestrial roaming subscribers, and 22.3 million terrestrial roaming-only subscribers.
A universal necessity in conducting business is ensuring that you are never out of touch. Iridium would provide this unique solution to business with the essential communications tool. This proposition of one phone, one number with the capability to be accessed anywhere, anytime was a message that target markets—the global traveler, the mining, rural, maritime industries, government, disaster relief, and community aid groups—would readily embrace.
Also at the same time of Iridium’s conception, there appeared to be another potentially lucrative opportunity in the telecommunications marketplace. When users of mobile or cellular phones crossed international borders, they soon discovered that there existed a lack of common standards, thus making some phones inoperable. Motorola viewed this as an opportunity to create a worldwide standard allowing phones to be used anywhere in the world.
The expected breakeven market for Iridium was estimated between 400,000 and 600,000 customers globally, assuming a reasonable usage rate per customer per month. With a launch date for Iridium service established for 1998, Iridium hoped to recover all of its investment within one year. By 2002, Iridium anticipated a customer base of 5 million users. The initial Iridium target market had been the vertical market, those of the industry, government, and world agencies that have defended needs and far-reaching communication requirements. Also important would be both industrial and public sector customers. Often isolated in remote locations outside of cellular coverage, industrial users were expected to use handheld Iridium satellite services to complement or replace their existing radio or satellite communications terminals. The vertical markets for Iridium would include:
Using its own marketing resources, Iridium appeared to have identified an attractive market segment after having screened over 200,000 people, interviewed 23,000 people from 42 countries, and surveyed over 3000 corporations.
Iridium would also need regional strategic partners, not only for investment purposes and to share the risks, but to provide services throughout their territories. The strategic regional partners or gateway operating companies would have exclusive rights to their territories and were obligated to market and sell Iridium services. The gateways would also be responsible for end-user sales, activation and deactivation of Iridium services, account maintenance, and billing.
Iridium would need each country to grant full licenses for access to the Iridium system. Iridium would need to identify the “priority” countries that account for the majority of the business plan.
Because of the number of countries involved in the Iridium network, Iridium would need to establish global Customer Care Centers for support services in all languages. No matter where an Iridium user was located, he or she would have access to a customer service representative in their native language. The Customer Care Centers would be strategically located to offer 24-hours-a-day, 7-daysa-week, and 365-days-a-year support.
THE “HIDDEN” BUSINESS CASE
The decision by Motorola to invest heavily into the Iridium Project may have been driven by a secondary or hidden business case. Over the years, Motorola achieved a reputation of being a first mover (i.e., first to market). With the Iridium Project, Motorola was poised to capture first-mover advantage in providing global telephone service via LEO satellites. In addition, even if the Iridium Project never resulted in providing service, Motorola would still have amassed valuable intellectual property that would make Motorola possibly the major player for years to come in satellite communications. There may have also been the desire of Robert and Christopher Galvin to have their names etched in history as the pioneers in satellite communication.
Good business cases identify the risks that the project must consider. For simplicity sake, the initial risks associated with the Iridium Project could be classified as follows.
Technology Risks: Although Motorola had some technology available for the Iridium Project, there was still the need to develop additional technology, specifically satellite communications technology. The development process was expected to take years and would eventually result in numerous patents.
Mark Gercenstein, Iridium’s vice president of operations, explains the system’s technological complexity:
More than 26 completely impossible things had to happen first, and in the right sequence (before we could begin operations)—like getting capital, access to the marketplace, global spectrum, the same frequency band in every country of operations.
While there was still some risk in the development of new technology, Motorola had the reputation of being a high-tech, can-do company. The engineers at Motorola believed that they could bring forth miracles in technology. Motorola also had a reputation for being a first mover with new ideas and products, and there was no reason to believe that this would not happen on the Iridium Project. There was no competition for Iridium at its inception.
Because the project schedule was more than a decade in duration, there was the risk of technology obsolescence. This required that certain assumptions be made concerning technology a decade downstream. Developing a new product is relatively easy if the environment is stable. But in a high-tech environment that is both turbulent and dynamic, it is extremely difficult to determine how customers will perceive and evaluate the product 10 years later.
Development Risks: The satellite communication technology, once developed, had to be manufactured, tested, and installed in the satellites and ground equipment. Even though the technology existed or would exist, there was still the transitional or development risks from engineering to manufacturing to implementation that would bring with it additional problems that were not contemplated or foreseen.
Financial Risks: The cost of the Iridium Project would most certainly be measured in the billions of dollars. This would include the costs for technology development and implementation, the manufacture and launch of satellites, the The Collective Belief
construction of ground support facilities, marketing, and supervision. Raising money from Wall Street’s credit and equity markets was years away. Investors were unlikely to put up the necessary hundreds of millions of dollars on merely an idea or a vision. The technology needed to be developed and possibly accompanied by the launch of a few satellites before the credit and equity markets would come on board.
Private investors were a possibility, but the greatest source of initial funding would have to come from the members of the Iridium consortium. While sharing the financial risks among the membership seemed appropriate, there was no question that bank loans and lines of credit would be necessary. Since the Iridium Project was basically an idea, the banks would require some form of collateral or guarantee for the loans. Motorola, being the largest stakeholder (and also with the “deepest pockets”), would need to guarantee the initial loans.
Marketing Risks: The marketing risks were certainly the greatest risks facing the Iridium membership. Once again, the risks were shared among its membership where each member was expected to sign up customers in its geographic area.
Each consortium member had to aggressively sign up customers for a product that didn’t exist yet, no prototypes existed to be shown to the customers, limitations on the equipment were unknown as yet, and significant changes in technology could occur between the time the customer signed up and the time the system was ready for use. Companies that see the need for Iridium today may not see the same need 10 years later.
Motivating the consortium partners to begin marketing immediately would be extremely difficult since marketing material was nonexistent. There was also the very real fear that the consortium membership would be motivated more so by the technology rather than the necessary size of the customer base required.
The risks were interrelated. The financial risks were highly dependent upon the marketing risks. If a sufficient customer base could not be signed up, there could be significant difficulty in raising capital.
THE COLLECTIVE BELIEF
Although the literature doesn’t clearly identify it, there was most likely a collective belief among the workers assigned to the Iridium Project. The collective belief is a fervent, and perhaps blind, desire to achieve that can permeate the entire team, the project sponsor, and even the most senior levels of management. The collective belief can make a rational organization act in an irrational manner.
When a collective belief exists, people are selected based upon their support for the collective belief. Nonbelievers are pressured into supporting the collective belief and team members are not allowed to challenge the results. As the collective belief grows, both advocates and nonbelievers are trampled. The pressure of the collective belief can outweigh the reality of the results.
There are several characteristics of the collective belief, which is why some large, high-tech projects are often difficult to kill:
THE EXIT CHAMPION
Project champions do everything possible to make their project successful. But what if the project champions, as well as the project team, have blind faith in the success of the project? What happens if the strongly held convictions and the collective belief disregard the early warning signs of imminent danger? What happens if the collective belief drowns out dissent?
In such cases, an exit champion must be assigned. The exit champion sometimes needs to have some direct involvement in the project in order to have credibility. Exit champions must be willing to put their reputation on the line and possibly face the likelihood of being cast out from the project team. According to
Sometimes it takes an individual, rather than growing evidence, to shake the collective belief of a project team. If the problem with unbridled enthusiasm starts as an unintended consequence of the legitimate work of a project champion, then what may be needed is a countervailing force—an exit champion. These people are more than devil’s advocates. Instead of simply raising questions about a project, they seek objective evidence showing that problems in fact exist. This allows them to challenge—or, given the ambiguity of existing data, conceivably even to confirm—the viability of a project. They then take action based on the data.
The larger the project and the greater the financial risk to the firm, the higher up the exit champion should reside. On the Iridium Project, the collective belief Iridium’s Infancy Years
originated with Galvin, Motorola’s CEO. Therefore, who could possibly function as the exit champion on the Iridium Project? Since it most likely should be someone higher up than Galvin, the exit champion should have been someone on the board of directors or even the entire Iridium board of directors.
Unfortunately, the entire Iridium board of directors was also part of the collective belief and shirked its responsibility for oversight on the Iridium Project. In the end, Iridium had no exit champion. Large projects incur large cost overruns and schedule slippages. Making the decision to cancel such a project, once it has started, is very difficult, according to David Davis.
The difficulty of abandoning a project after several million dollars have been committed to it tends to prevent objective review and recosting. For this reason, ideally an independent management team—one not involved in the projects development— should do the recosting and, if possible, the entire review. . . . If the numbers do not hold up in the review and recosting, the company should abandon the project. The number of bad projects that make it to the operational stage serves as proof that their supporters often balk at this decision.
. . . Senior managers need to create an environment that rewards honesty and courage and provides for more decision making on the part of project managers. Companies must have an atmosphere that encourages projects to succeed, but executives must allow them to fail.
The longer the project, the greater the necessity for the exit champions and project sponsors to make sure that the business plan has “exit ramps” such that the project can be terminated before massive resources are committed and consumed. Unfortunately, when a collective belief exists, exit ramps are purposefully omitted from the project and business plans.
IRIDIUM’S INFANCY YEARS
By 1992, the Iridium Project attracted such stalwart companies as General Electric, Lockheed, and Raytheon. Some companies wanted to be involved to be part of the satellite technology revolution while others were afraid of falling behind the technology curve. In any event, Iridium was lining up strategic partners, but slowly.
The Iridium Plan, submitted to the FCC in August, 1992, called for a constellation of 66 satellites, expected to be in operation by 1998, more powerful than originally proposed, thus keeping the project’s cost at the previously estimated $3.37 billion. But the Iridium Project, while based on lofty forecasts of available customers, was now attracting other companies competing for FCC approval on similar satellite systems including Loral Corp., TRW Inc., and Hughes Aircraft Co., a unit of General Motors Corp. There were at least nine companies competing for the potential billions of dollars in untapped revenue possible from satellite communications.
Even with the increased competition, Motorola was signing up partners. Motorola had set an internal deadline of December 15, 1992, to find the necessary funding for Iridium. Signed letters of intent were received from the Brazilian government and United Communications Co., of Bangkok, Thailand, to buy 5 percent stakes in the project, each now valued at about $80 million. The terms of the agreement implied that the Iridium consortium would finance the project with roughly 50 percent equity and 50 percent debt.
When the December 15 deadline arrived, Motorola was relatively silent on the signing of funding partners, fueling speculation that it was having trouble. Motorola did admit that the process was time-consuming because some investors required government approval before proceeding. Motorola was expected to announce at some point, perhaps in the first half of 1993, whether it was ready to proceed with the next step, namely receiving enough cash from its investors, securing loans, and ordering satellite and group equipment.
As the competition increased, so did the optimism about the potential size of the customer base.
“We’re talking about a business generating billions of dollars in revenue,” says John F. Mitchell, Vice Chairman at Motorola. “Do a simple income extrapolation,” adds Edward J. Nowacki, a general manager at TRW’s Space & Electronics Group, Redondo Beach, Calif., which plans a $1.3 billion, 12-satellite system called Odyssey. “You conclude that even a tiny fraction of the people around the world who can afford our services will make them successful.” Mr. Mitchell says that if just 1% to 1.5% of the expected 100 million cellular users in the year 2000 become regular users at $3 a minute, Iridium will breakeven. How does he know this? “Marketing studies,” which he won’t share. TRW’s Mr. Nowacki says Odyssey will blanket the Earth with two-way voice communication service priced at “only a slight premium” to cellular. “With two million subscribers we can get a substantial return on our investment,” he says. “Loral Qualcomm Satellite Services, Inc. aims to be the ‘friendly’ satellite by letting phone-company partners use and run its system’s ground stations,” says Executive Vice President Anthony Navarra. “By the year 2000 there will be 15 million unserved cellular customers in the world,” he says.
But while Motorola and other competitors were trying to justify their investment with “inflated market projections” and a desire from the public for faster and clearer reception, financial market analysts were not so benevolent. First, Iridium’s Infancy Years
market analysts questioned the size of the customer base that would be willing to pay $3000 or more for a satellite phone in addition to $3–$7 per minute for a call. Second, the system required a line-of-sight transmission, which meant that the system would not work in buildings or in cars. If a businessman were attending a meeting in Bangkok and needed to call his company, he must exit the building, raise the antenna on his $3000 handset, point the antenna toward the heavens, and then make the call. Third, the low-flying satellites would eventually crash into the Earth’s atmosphere every 5–7 years because of atmospheric drag and would need to be replaced. That would most likely result in high capital costs. And fourth, some industry analysts believed that the startup costs would be closer to $6–$10 billion rather than the $3.37 billion estimated by Iridium. In addition, the landbased cellular phone business was expanding in more countries, thus creating another competitive threat for Iridium.
The original business case needed to be reevaluated periodically. But with strong collective beliefs and no exit champions, the fear of a missed opportunity, irrespective of the cost, took center stage.
Reasonably sure that 18 out of 21 investors were on board, Motorola hoped to start launching test satellites in 1996 and begin commercial service by 1998. But critics argued that Iridium might be obsolete by the time it actually started working.
Eventually, Iridium was able to attract financial support from 19 strategic partners:
Seventeen of the strategic partners also participated in gateway operations with the creation of operating companies.
The Iridium board of directors consisted of 28 telecommunications executives. All but one board member was a member of the consortium as well. This made it very difficult for the board to fulfill its oversight obligation, effectively giving the members’ vested/financial interest in the Iridium Project.
In August 1993, Lockheed announced that it would receive $700 million in revenue for satellite construction. Lockheed would build the satellite structure, solar panels, attitude and propulsion systems, along with other parts, and engineering support. Motorola and Raytheon Corp. would build the satellite’s communications gear and antenna.
In April 1994, McDonnell Douglas Corp. received from Iridium a $400 million contract to launch 40 satellites for Iridium. Other contracts for launch services would be awarded to Russia’s Khrunichev Space Center and China’s Great Wall Industry Corporation, both members of the consortium. The lower-cost contracts with Russia and China were putting extraordinary pressure on U.S. providers to lower their costs.
Also at the same time, one of Iridium’s competitors, the Globalstar system, which was a 48-satellite mobile telephone system led by Loral Corporation, announced that it intended to charge 65 cents per minute in the areas it served. Iridium’s critics were arguing that Iridium would be too pricey to attract a high volume of callers.
In September 1994, Iridium said that it had completed its equity financing by raising an additional $733.5 million. This brought the total capital committed to Iridium through equity financing to $1.57 billion. The completion of equity financing permitted Iridium to enter into debt financing to build the global wireless satellite network.
In September 1995, Iridium announced that it would be issuing $300 million 10-year senior-subordinated discounted notes rated Caa by Moody’s and CCC+ by Standard & Poor’s, via the investment banker Goldman Sachs Inc. The bonds were considered to be high-risk, high-yield “junk” bonds after investors concluded that the rewards weren’t worth the risk.
The rating agencies cited the reasons for the low rating to be yet unproven sophisticated technology, and the fact that a significant portion of the system’s hardware would be located in space. But there were other serious concerns:
Iridium was set up as “project financing” in which case, if a default occurred, only the assets of Iridium could be attached. With project financing, the consortium’s investors would be held harmless for any debt incurred from the stock and bond markets and could simply walk away from Iridium. These risks associated with project financing were well understood by those that invested in the equity and credit markets.
Goldman Sachs & Co., the lead underwriter for the securities offering, determined that for the bond issue to be completed successfully, there would need to exist a completion guarantee from investors with deep pockets, such as Motorola. Goldman Sachs cited a recent $400 million offering by one of Iridium’s competitors, Globalstar, which had a guarantee from the managing general partner, Loral Corp.
Because of the concern by investors, Iridium withdrew its planned $300 million debt offering. Also, Globalstar, even with its loan guarantee, eventually withdrew its $400 million offering. Investors wanted both an equity position in Iridium and a 20 percent return. Additionally, Iridium would need to go back to its original 17-member consortium and arrange for internal financing.
In February 1996, Iridium had raised an additional $315 million from the 17-member consortium and private investors. In August 1996, Iridium had secured a $750 million credit line with 62 banks co-arranged by Chase Securities Inc., a unit of Chase Manhattan Corp. and the investment banking division of Barclays Bank PLC. The credit line was oversubscribed by more than double its original goal because the line of credit was backed by a financial guarantee by Motorola and its AAA credit rating. Because of the guarantee by Motorola, the lending rate was slightly more than the 5.5 percent baseline international commercial lending rate and significant lower than the rate in the $300 million bond offering that was eventually recalled.
Despite this initial success, Iridium still faced financial hurdles. By the end of 1996, Iridium planned on raising more than $2.65 billion from investors. It was estimated that more than 300 banks around the globe would be involved, and that this would be the largest private debt placement ever. Iridium believed that this debt placement campaign might not be that difficult since the launch date for Iridium services was getting closer.
THE M-STAR PROJECT
In October 1996, Motorola announced that it was working on a new project dubbed M-Star, which would be a $6.1 billion network of 72 low-orbit satellites capable of worldwide voice, video, and high-speed data links targeted at the international community. The project was separate from the Iridium venture and was expected to take 4 years to complete after FCC approval. According to Bary Bertiger, now corporate vice president and general manager of Motorola’s satellite communications group, “Unlike Iridium, Motorola has no plans to detach M-Star as a separate entity. We won’t fund it ourselves, but we will have fewer partners than in Iridium.”
The M-Star Project raised some eyebrows in the investment community. Iridium employed 2000 people but M-Star had only 80. The Iridium Project generated almost 1100 patents for Motorola, and that intellectual property would most likely be transferred to M-Star. Also, Motorola had three contracts with Iridium for construction and operation of the global communication system providing for approximately $6.5 billion in payments to Motorola over a 10-year period that began in 1993. Was M-Star being developed at the expense of Iridium? Could M-Star replace Iridium? What would happen to the existing 17-member consortium at Iridium if Motorola were to withdraw its support in lieu of its own internal competitive system?
A NEW CEO
In 1996, Iridium began forming a very strong top management team with the hiring of Dr. Edward Staiano as CEO and vice chairman. Prior to joining Iridium in Satellite Launches
1996, Staiano had worked for Motorola for 23 years, during which time he developed a reputation for being hard-nosed and unforgiving. During his final 11 years with Motorola, Staiano led the company’s General Systems Sector to record growth levels. In 1995, the division accounted for approximately 40 percent of Motorola’s total sales of $27 billion. In leaving Motorola’s payroll for Iridium’s, Staiano gave up a $1.3 million per year contract with Motorola for a $500,000 base salary plus 750,000 Iridium stock options that vested over a 5-year period.
I was spending 40 percent to 50 percent of my time [at Motorola] on Iridium anyway . . . If I can make Iridium’s dream come true, I’ll make a significant amount of money.
At 11:28 AM on a Friday morning the second week of January 1997, a Delta 2 rocket carrying a Global Positioning System (GPS) exploded upon launch, scattering debris above its Cape Canaveral launch pad. The launch, which was originally scheduled for the third quarter of 1996, would certainly have an impact on Iridium’s schedule, while an industry board composed of representatives from McDonnell-Douglas and the Air Force determined the cause of the explosion. Other launches had already been delayed for a variety of technical reasons.
In May of 1997, after six failed tries, the first five Iridium satellites were launched. Iridium still believed that the target date for launch of service, September 1998, was still achievable but that all slack in the schedule had been eliminated due to the earlier failures.
By this time, Motorola had amassed tremendous knowledge on how to massproduce satellites. As described by Bennahum:
The Iridium constellation was built on an assembly line, with all the attendant reduction in risk and cost that comes from doing something over and over until it is no longer an art but a process. At the peak of this undertaking, instead of taking 18 to 36 months to build one satellite, the production lines disgorged a finished bird every four and a half days, sealed it in a container, and placed it on the flatbed of an idling truck that drove it to California or Arizona, where a waiting Boeing 747 carried it to a launchpad in the mountains of Taiyuan, China, or on the steppes of Baikonur in Kazakhstan.20
AN INITIAL PUBLIC OFFERING (IPO)
Iridium was burning cash at the rate of $100 million per month. Iridium filed a preliminary document with the Security and Exchange Commission (SEC) for an initial public offering of 10 million shares to be offered at $19–$21 a share. Because of the launch delays, the IPO was delayed.
In June of 1997, after the first five satellites were placed in orbit, Iridium filed for an IPO of 12 million shares priced at $20 per share. This would cover about 3 months of operating expenses including satellite purchases and launch costs. The majority of the money would go to Motorola.
SIGNING UP CUSTOMERS
The reality of the Iridium concept was now at hand. All that was left to do was to sign up 500,000–600,000 customers, as predicted, to use the service. Iridium set aside $180 million for a marketing campaign including advertising, public relations, and worldwide, direct mail effort. Part of the advertising campaign included direct mail translated into 13 languages, ads on television and on airlines, airport booths, and Internet web pages.
How to market Iridium was a challenge. People would certainly hate the phone. According to John Windolph, executive director of marketing communications at Iridium, “It’s huge! It will scare people. It is like a brick-size device with an antenna like a stout bread stick. If we had a campaign that featured our product, we’d lose.” The decision was to focus on the fears of being out of touch. Thus, the marketing campaign began. But Iridium still did not have a clear picture of who would subscribe to the system. An executive earning $700,000 would probably purchase the bulky phone, have his or her assistant carry the phone in his or her briefcase, be reimbursed by the company for the use of the phone, and pay $3–$7 per minute for calls, also a business expense. But are there 600,000 executives worldwide that need the service?
There were several other critical questions that needed to be addressed. How do we hide or downplay the $3400 purchase price of the handset and the usage cost of $7 per minute? How do we avoid discussions about competitors that are offering similar services at a lower cost? With operating licenses in about 180 countries, do we advertise in all of them? Do we take out ads in Oil and Gas Daily? Do we advertise in girlie magazines? Do we use full-page or double-page spreads?
Iridium had to rely heavily upon its “gateway” partners for marketing and sales support. Iridium itself would not be able to reach the entire potential audience. Would the gateway partners provide the required marketing and sales support? Do the gateway partners know how to sell the Iridium system and the associated products?
Iridium’s Rapid Ascent
The answer to these questions appeared quickly.
Over a matter of weeks, more than one million sales inquiries poured into Iridium’s sales offices. They were forwarded to Iridium’s partners—and many of them promptly disappeared, say several Iridium insiders. With no marketing channels and precious few sales people in place, most global partners were unable to follow up on the inquiries. A mountain of hot sales tips soon went cold.
IRIDIUM’S RAPID ASCENT
On November 1, 1998, the Iridium system was officially launched. It was truly a remarkable feat that the 11-year project was finally launched, just a little more than a month late.
After 11 years of hard work, we are proud to announce that we are open for business. Iridium will open up the world of business, commerce, disaster relief, and humanitarian assistance with our first-of-its-kind global communications service . . . The potential use of Iridium products is boundless. Business people who travel the globe and want to stay in touch with home and office, industries that operate in remote areas—all will find Iridium to be the answer to their communications needs.
On November 2, 1998, Iridium began providing service. With the Iridium system finally up and running, most financial analysts issued “buy” recommendations for Iridium stock with expected yearly revenues of $6–$7 billion within 5 years. On January 25, 1999, Iridium held a news conference to discuss its earnings for the fourth quarter of 1998. Ed Staiano, CEO of Iridium stated:
In the fourth quarter of 1998, Iridium made history as we became the first truly global mobile telephone company. Today, a single wireless network, the Iridium Network, covers the planet. And we have moved into 1999 with an aggressive strategy to put a large number of customers on our system, and quickly transform Iridium from a technological event to a revenue generator. We think the prospects for doing this are excellent. Our system is performing at a level beyond expectations.
Financing is now in place through projected cash flow positives. Customer interest remains very high and a number of potentially large customers have now evaluated our service and have given it very high ratings. With all of this going for us, we are in position to sell the service and that is precisely where we are focusing the bulk of our efforts.
Roy Grant, CEO of Iridium, stated:
Last week Iridium raised approximately $250 million through a very successful 7.5 million-share public offering. This offering had three major benefits. It provided $250 million of cash to our balance sheet. It increased our public float to approximately 20 million shares. And it freed up restrictions placed on $300 million of the $350 million of Motorola guarantees. These restrictions were placed on that particular level of guarantees by our bankers in our $800 million secured credit facility.
With this $250 million, combined with the $350 million of additional guarantees from Motorola, this means we have approximately $600 million of funds in excess of what we need to break cash flow breakeven. This provides a significant contingency for the company.
In order to make its products and services known to travelers, Iridium agreed to acquire Claircom Corporation from AT&T and Rogers Cantel Mobile Communications for about $65 million. Claircom provided in-flight telephone systems for U.S. planes as well as equipment for international carriers. The purchase of Claircom would be a marketing boost for Iridium.
The problems with large, long-term technology projects were now appearing in the literature. As described by Bennahum:
“This system does not let you do what a lot of wired people want to do,” cautions Professor Heather Hudson, who runs the telecommunications program at the University of San Francisco and studies the business of wireless communications. “Nineteen-nineties technologies are changing so fast that it is hard to keep up. Iridium is designed from a 1980s perspective of a global cellular system. Since then, the Internet has grown and cellular telephony is much more pervasive. There are many more opportunities for roaming than were assumed in 1989. So there are fewer businesspeople who need to look for an alternative to a cell phone while they are on the road.”
Additionally, toward the late 1990s, some industry observers felt that Motorola had additional incentive to ensure that Iridium succeeded, irrespective of the costs—namely, protecting its reputation. Between 1994 and 1997, Motorola had suffered slowing sales growth, a decline in net income, and declining margins. Moreover, the company had experienced several previous business mishaps, including a failure to anticipate the cellular industry’s switch to digital cell phones, which played a major role in Motorola’s more than 50 percent shareprice decline in 1998.
IRIDIUM’S RAPID DESCENT
It took more than a decade for the Iridium Project to ascend and only a few months for descent. In the first week of March, almost 5 weeks after the January teleconference, Iridium’s financial woes began to surface. Iridium had expected 200,000 subscribers by the end of 1998 and additional subscribers at a rate of 40,000 per month. Iridium’s bond covenants stated a target of 27,000 subscribers by the end of March. Failure to meet such a small target could send investor confidence spiraling downward. Iridium had only 10,000 subscribers. The market that was out there 10 years ago was not the market that was there today. Also, 10 years ago there was little competition for Iridium.
Iridium cited the main cause of the shortfall in subscriptions as being shortages of phones, glitches in some of the technology, software problems, and, most important, a lack of trained sales channels. Iridium found out that it had to train a sales staff and that Iridium itself would have to sell the product, not its distributors. The investor community did not appear pleased with the sales problem that should have been addressed years ago, not 4 months into commercial service.
Iridium’s advertising campaign was dubbed “Calling Planet Earth” and promised that you had the freedom to communicate anytime and anywhere. This was not exactly true because the system could not work within buildings or even cars. Furthermore, Iridium underestimated the amount of time subscribers would require to examine and test the system before signing on. In some cases, this would be six months.
Many people blamed marketing and sales for Iridium’s rapid descent:
True, Iridium committed so many marketing and sales mistakes that its experiences could form the basis of a textbook on how not to sell a product. Its phones started out costing $3,000, were the size of a brick, and didn’t work as promised. They weren’t available in stores when Iridium ran a $180 million advertising campaign. And Iridium’s prices, which ranged from $3.00 to $7.50 a call, were out of this world.
Iridium’s business plan was flawed. With service beginning on November 2, 1998, it was unlikely that 27,000 subscribers would be on board by March of 1999, given the time required to test the product. The original business plan required that the consortium market and sell the product prior to the onset of service. But selling the service from just a brochure was almost impossible. Subscribers want to touch the phone, use it, and test it prior to committing to a subscription.
Iridium announced that it was entering into negotiations with its lenders to alter the terms of an $800 million secured credit agreement due to the weakerthan-expected subscriber and revenue numbers. Covenants on the credit agreement included the following:
Cash Revenue Revenue
($ Millions) ($ Millions)
March 31, 1999
$ 4 $ 30
June 30, 1999
Sept. 30, 1999
The stock, which had traded as high as almost $73 per share, was now at approximately $20 per share. And, in yet another setback, the chief financial officer, Roy T. Grant, resigned.
Iridium’s CEO, Ed Staiano, resigned at the April 22 board meeting. Sources believed that Staiano resigned when the board nixed his plan requesting additional funds to develop Iridium’s own marketing and distribution team rather than relying on its strategic partners. Sources also stated another issue in that Staiano had cut costs to the barebones at Iridium but could not get Motorola to reduce its lucrative $500 million service contract with Iridium. Some people believed that Staiano wanted to reduce the Motorola service contract by up to 50 percent. John Richardson, the CEO of Iridium Africa Corp., was assigned as interim CEO. Richardson’s expertise was in corporate restructuring. For the quarter ending March, Iridium said it had a net loss of $505.4 million, or $3.45 a share. The stock fell to $15.62 per share. Iridium managed to attract just 10,294 subscribers 5 months after commercial rollout.
One of Richardson’s first tasks was to revamp Iridium’s marketing strategy.
Iridium was unsure as to what business it was in. According to Richardson,
The message about what this product was and where it was supposed to go changed from meeting to meeting. . . . One day, we’d talk about cellular applications, the next
Iridium’s Rapid Descent
day it was a satellite product. When we launch in November, I’m not sure we had a clear idea of what we wanted to be.
Iridium officially announced that it did not expect to meet its targets specified under the $800 million loan agreement. Lenders granted Iridium a 2-month extension. The stock dropped to $10.44 per share, party due to a comment by Motorola that it might withdraw from the ailing venture.
Wall Street began talking about the possibility of bankruptcy. But Iridium stated that it was revamping its business plan and by month’s end hoped to have chartered a new course for its financing. Iridium also stated in a regulatory filing that it was uncertain whether it would have enough cash to complete the agreement to purchase Claircom Communications Group Inc., an in-flight telephoneservice provider, for the promised $65 million in cash and debt.
Iridium had received extensions on debt payments because the lending community knew that it was no small feat transforming from a project plan to an operating business. Another reason why the banks and creditors were willing to grant extensions was because bankruptcy was not a viable alternative. The equity partners owned all of the Earth stations, all distribution, and all regulatory licenses. If the banks and creditors forced Iridium into bankruptcy, they could end up owning a satellite constellation that could not talk to the ground or gateways.
Iridium received an additional 30-day extension beyond the 2-month extension it had already received. Iridium was given until June 30 to make a $90 million bond payment. Iridium began laying off 15 percent of its 550 employee workforce including two senior officers. The stock had now sunk to $6 per share and the bonds were selling at 19 cents on the dollar. John Richardson, CEO of Iridium, said: “We did all of the difficult stuff well, like building the network, and did all of the no-brainer stuff at the end poorly.”
In a later interview John Richardson stated:
Iridium’s major mistake was a premature launch for a product that wasn’t ready. People became so obsessed with the technical grandeur of the project that they missed fatal marketing traps . . . Iridium’s international structure has proven almost impossible to manage: the 28 members of the board speak multiple languages, turning meetings into mini-U.N. conferences complete with headsets translating the proceedings … into five languages.
We’re a classic MBA case study in how not to introduce a product. First we created a marvelous technological achievement. Then we asked how to make money on it.
Iridium was doing everything possible to avoid bankruptcy. Time was what Iridium needed. Some industrial customers would take 6–9 months to try out a new product, but would be reluctant to subscribe if it appeared that Iridium would be out of business in 6 months. In addition, Iridium’s competitors were lowering their prices significantly-putting further pressure on Iridium. Richardson then began providing price reductions of up to 65 percent off of the original price for some of Iridium’s products and services.
The banks and investors agreed to give Iridium yet a third extension to August 11 to meet its financial covenants. Everyone seemed to understand that the restructuring effort was much broader than originally contemplated.
Motorola, Iridium’s largest investor and general contractor, admitted that the project may have to be shut down and liquidated as part of bankruptcy proceedings unless a restructuring agreement could be reached. Motorola also stated that if bankruptcy occurred, Motorola would continue to maintain the satellite network, but for a designated time period only.
Iridium had asked its consortium investors and contractors to come up with more money. But to many consortium members, it looked like they would be throwing good money after bad. Several partners made it clear that they would simply walk away from Iridium rather than providing additional funding. That could have a far-reaching effect on the service at some locations. Therefore, all partners had to be involved in the restructuring. Wall Street analysts expected Iridium to be allowed to repay its cash payments on its debt over several years or offer debt holders an equity position in Iridium. It was highly unlikely that Iridium’s satellites orbiting the Earth would be auctioned off in bankruptcy court.
On August 12, Iridium filed for bankruptcy protection. This was like having “a dagger stuck in their heart” for a company that a few years earlier had predicted financial breakeven in just the first year of operations. This was one of the 20 largest bankruptcy filings up to this time. The stock, which had been trading as little as $3 per share, was suspended from the NASDAQ on August 13, 1999.
The Iridum “Flu”
Iridium’s phone calls had been reduced to around $1.40–$3 per minute and the handsets were reduced to $1500 per unit.
There was little hope for Iridium. Both the business plan and the technical plan were flawed. The business plan for Iridium seemed like it came out of the film “Field of Dreams” where an Iowa corn farmer was compelled to build a baseball field in the middle of a corn crop. A mysterious voice in his head said, “Build it and they will come.” In the film, he did, and they came. While this made for a good plot for a Hollywood movie, it made a horrible business plan. In 1992, Herschel Shosteck, a telecommunications consultant said: “If you build Iridium,
people may come. But what is more likely is, if you build something cheaper, people will come to that first.”
The technical plan was designed to build the holy grail of telecommunications. Unfortunately, after spending billions, the need for the technology changed over time. The engineers that designed the system, many of whom had worked previously on military projects, lacked an understanding of the word “affordability” and the need for marketing a system to more than just one customer, namely the Department of Defense. “Satellite systems are always far behind the technology curve. Iridium was completely lacking the ability to keep up with Internet time,” Stated Bruce Egan, senior fellow at Columbia University’s Institute for Tele-Information.
Leo Mondale resigned as Iridium’s chief financial officer. Analysts believed that Mondale’s resignation was the result of a successful restructuring no longer being possible. According to one analyst, “If they [Iridium] were close [to a restructuring plan], they wouldn’t be bringing in a whole new team.”
THE IRIDIUM “FLU”
The bankruptcy of Iridium was having a flulike effect on the entire industry. ICO Global Communications, one of Iridium’s major competitors, also filed for bankruptcy protection just 2 weeks after the Iridium filing. ICO failed to raise $500 million it sought from public-rights offerings that had already been extended twice. Another competitor, the Globalstar Satellite Communications System, was still financially sound. Anthony Navarro, Globalstar’s chief operating officer, stated “They [Iridium] set everybody’s expectations way too high.”33
SEARCHING FOR A WHITE KNIGHT
Iridium desperately needed a qualified bidder who would function as a white knight. It was up to the federal bankruptcy court to determine whether someone was a qualified bidder. A qualified bidder was required to submit a refundable cash deposit or letter of credit issued by a respected bank that would equal the greater of $10 million or 10 percent of the value of the amount bid to take control of Iridium.
According to bankruptcy court filing, Iridium was generating revenue of $1.5 million per month. On December 9, 1999, Motorola agreed to a $20 million cash infusion for Iridium. Iridium desperately needed a white knight quickly or it could run out of cash by February 15, 2000. With a monthly operating cost of $10 million, and a staggering cost of $300 million every few years for satellite replenishment, it was questionable if anyone could make a successful business from Iridium’s assets because of asset specificity.
The cellular-phone entrepreneur Craig McCaw planned on a short-term cash infusion while he considered a much larger investment to rescue Iridium. He was also leading a group of investors who pledged $1.2 billion to rescue the ICO satellite system that filed for bankruptcy protection shortly after the Iridium filing.
Several supposedly white knights came forth, but Craig McCaw’s group was regarded as the only credible candidate. Although McCaw’s proposed restructuring plan was not fully disclosed, it was expected that Motorola’s involvement would be that of a minority stakeholder. Also, under the restructuring plan, Motorola would reduce its monthly fee for operating and maintaining the Iridium system from $45 million to $8.8 million.
DEFINITION OF FAILURE (OCTOBER, 1999)
The Iridium network was an engineering marvel. Motorola’s never-say-die attitude created technical miracles and overcame NASA-level technical problems. Iridium overcame global political issues, international regulatory snafus, and a range of other geopolitical issues on seven continents. The Iridium system was, in fact, what Motorola’s Galvin called the eighth wonder of the world.
But did the bankruptcy indicate a failure for Motorola? Absolutely not! Motorola collected $3.65 billion in Iridium contracts. Assuming $750 million in The Satellite Deorbiting Plan
profit from these contracts, Motorola’s net loss on Iridium was about $1.25 billion. Simply stated, Motorola spent $1.25 billion for a project that would have cost it perhaps as much as $5 billion out of its own pocket had it wished to develop the technology itself. Iridium provided Motorola with more than 1000 patents in building satellite communication systems. Iridium allowed Motorola to amass a leadership position in the global satellite industry. Motorola was also signed up as the prime contractor to build the 288-satellite “Internet in the Sky,” dubbed the Teledesic Project. Backers of the Teledesic Project, which had a price tag of $15 billion to transmit data, video, and voice, included Boeing, Microsoft’s Chairman Bill Gates, and cellular magnate Craig McCaw. Iridium had enhanced Motorola’s reputation for decades to come.
Motorola stated that it had no intention of providing additional funding to ailing Iridium, unless of course other consortium members followed suit. Several members of the consortium stated that they would not provide any additional investment and were considering liquidating their involvement in Iridium.
In March 2000 McCaw withdrew its offer to bail out Iridium even at a deep discount asserting that his efforts would be spent on salvaging the ICO satellite system instead. This, in effect, signed Iridium’s death warrant. One of the reasons for McCaw’s reluctance to rescue Iridium may have been the discontent by some of the investors who would have been completely left out as part of the restructuring effort, thus losing perhaps their entire investment.
THE SATELLITE DEORBITING PLAN
With the withdrawal of McCaw’s financing, Iridium notified the U.S. Bankruptcy Court that Iridium had not been able to attract a qualified buyer by the deadline assigned by the court. Iridium would terminate its commercial service after 11:59 PM on March 17, 2000, and that it would begin the process of liquidating its assets.
Immediately following the Iridium announcement, Motorola issued the following press release:
Motorola will maintain the Iridium satellite system for a limited period of time while the deorbiting plan is being finalized. During this period, we also will continue to work with the subscribers in remote locations to obtain alternative communications. However, the continuation of limited Iridium service during this time will depend on whether the individual gateway companies, which are separate operating companies, remain open.
In order to support those customers who purchased Iridium service directly from Motorola, Customer Support Call Centers and a website that are available 24 hours a day, seven days a week have been established by Motorola. Included in the information for customers is a list of alternative satellite communications services.
The deorbiting plan would likely take 2 years to complete at a cost of $50–$70 million. This would include all 66 satellites and the other 22 satellites in space serving as spare or decommissioned failures. Iridium would most likely deorbit the satellites four at a time by firing their thrusters to drop them into the atmosphere where they would burn up.
IRIDIUM IS RESCUED FOR $25 MILLION
In November 2000, a group of investors led by an airline executive won bankruptcy court approval to form Iridium Satellite Corporation and purchase all remaining assets of failed Iridium Corporation. The purchase was at a fire-sale price of $25 million, which was less than a penny on the dollar. As part of the proposed sale, Motorola would turn over responsibility for operating the system to Boeing. Although Motorola would retain a 2 percent stake in the new system, Motorola would have no further obligations to operate, maintain, or decommission the constellation.
Almost immediately after the announcement, Iridium Satellite was awarded a $72 million contract from the Defense Information Systems Agency, which is part of the Department of Defense (DoD). Dave Oliver, principal deputy undersecretary of Defense for Acquisition stated:
“Iridium will not only add to our existing capability, it will provide a commercial alternative to our purely military systems. This may enable real civil/military dual use, keep us closer to leading edge technologically, and provide a real alternative for the future.”
Iridium had been rescued from the brink of extinction. As part of the agreement, the newly formed company acquired all of the assets of the original Iridium and its subsidiaries. This included the satellite constellation, the terrestrial network, Iridium real estate, and the intellectual property originally developed by Iridium. Because of the new company’s significantly reduced cost structure, it was able to develop a workable business model based upon a targeted market for Iridium’s products and services. Weldon Knape, WCC chief executive officer stated: “Everyone thinks the Iridium satellites crashed and burned, but they’re all still up there.”
A new Iridium phone costs $1495 and is the size of a cordless home phone. Older, larger models start at $699 or one can be rented for about $75 per week. Service costs $1–$1.60 a minute.
February 6, 2006, Iridium Satellite declared that 2005 was the best year ever. The company had 142,000 subscribers, which was a 24 percent increase from 2004, and the 2005 revenue was 55 percent greater than in 2004. According to Carmen Lloyd, Iridium’s CEO, “Iridium is on an exceptionally strong financial foundation with a business model that is self-funding.”
For the year ending 2006, Iridium had $212 million in sales and $54 million in profit. Iridium had 180,000 subscribers and a forecasted growth rate of 14–20 percent per year. Iridium had changed its business model, focusing on sales and marketing first and hype second. This allowed it to reach out to new customers and new markets.
The benefit to Motorola, potentially at the expense of Iridium and its investors, did not go unnoticed. At least 20 investor groups filed suit against Motorola and Iridium, citing:
THE BANKRUPTCY COURT RULING
On September 4, 2007, after almost 10 months, the Bankruptcy Court in Manhattan ruled in favor of Motorola and irritated the burned creditors that had hoped to get a $3.7 billion judgment against Motorola. The judge ruled that even though the capital markets were “terribly wrong” about Iridium’s hopes for huge profits, Iridium was “solvent” during the critical period when it successfully raised rather impressive amounts of debt and equity in the capital markets.
The court said that even though financial experts now know that Iridium was a hopeless one-way cash flow, flawed technology project, and doomed business model, Iridium was solvent at the critical period of fundraising. Even when the bad news began to appear, Iridium’s investors and underwriters still believed that Iridium had the potential to become a viable enterprise.
The day after the court ruling, newspapers reported that Iridium LLC, the now privately held company, was preparing to raise about $500 million in a private equity offering to be followed by an IPO within the next year or two.
There were several reasons for Iridium’s collapse:
Iridium’s Service. Iridium knew its phones would be too large and too expensive to compete with cellular service, forcing the company to play in areas where cellular was unavailable. With this constraint in mind, Iridium sought a target market by focusing on international business executives who frequently traveled to remote areas where cellular phone service wasn’t available. Although this market plan predated the rise of cell phones, Iridium remained focused on the business traveler group through the launch of its service. As late as 1998, CEO Staiano predicted Iridium would have 500,000 subscribers by the end of 1999.
One of the main problems with Iridium’s offering was that terrestrial cellular had spread faster than the company had originally expected. In the end, cellular was available. Due to Iridium’s elaborate technology, the concept-todevelopment time was 11 years—during this period, cellular networks spread to cover the overwhelming majority of Europe and even migrated to developing countries such as China and Brazil. In short, Iridium’s marketing plan targeted a segment—business travelers—whose needs were increasingly being met by cell phones that offered significantly better value than Iridium.
Iridium’s technology depended on line-of-sight between the phone antenna and the orbiting satellite, subscribers were unable to use the phone inside moving cars, inside buildings, and in many urban areas. Moreover, even in open fields users had to align the phone just right in order to get a good connection. As a top industry consultant said to us in an interview, “you can’t expect a CEO traveling on business in Bangkok to leave a building, walk outside on a street corner, and pull out a $3,000 phone.” Additionally, Iridium lacked adequate data capabilities, an increasingly important feature for business users. Making matters worse were annoyances such as the fact that battery recharging in remote areas required special solar-powered accessories. These limitations made the phone a tough sell to Iridium’s target market of high-level traveling businessmen.
The design of Iridium’s phone also hampered adoption. In November 1997, John Windolph, Iridium director of marketing communications, described the handset in the following manner: “It’s huge! It will scare people. If we had a campaign that featured our product, we’d lose.” Yet a year later Iridium went forward with essentially the same product. The handset, although smaller than competitor Comsat’s Planet 1, was still literally the size of a brick.
Poor Operational Execution Plagued Iridium. Manufacturing problems also caused Iridium’s launch to stumble out of the gate. Management launched the service before enough phones were available from one of its two main suppliers, Kyocera, which was experiencing software problems at the time. Ironically, this manufacturing bottleneck meant that Iridium couldn’t even get phones to the few subscribers that actually wanted one. The decision to launch service in November 1998, in spite of the manufacturing problems, was made by CEO Staiano, although not without opposition. As one report put it, “[John Richardson] claimed to be vociferous in board meetings, arguing against the November launch. Neither the service, nor the service providers, were ready. Supply difficulties meant that there were few phones available in the market.”
Iridium’s Partners Did Not Provide Adequate Sales and Marketing Support. Although at first Motorola had difficulty attracting investors for Iridium, by 1994 Iridium LLC had partnerships with 18 companies including Sprint, Raytheon, Lockheed Martin, and a variety of companies from China, the Middle East, Africa, India, and Russia. In exchange for investments of $3.7 billion, the partners received equity and seats on Iridium LLC’s board of directors. In 1998, 27 of the 28 directors on Indium’s board were either Iridium employees or directly appointed by Iridium’s partners.
Iridium’s partners would ultimately control marketing, pricing, and distribution when the service came on line. Iridium’s revenues came from wholesale rates for its phone service. Unfortunately for Iridium, its partners, outside the United States in particular, delayed setting up marketing teams and distribution channels. “The gateways were very often huge telecoms,” said Stephane Chard, chief analyst at Euroconsult, a Paris-based research firm. “To them, Iridium was a tiny thing.” So tiny, in fact, that Iridium’s partners failed to build sales teams, create marketing plans, or set up distribution channels for their individual countries. As the Wall Street Journal reported, “with less than six months to go before the launch of the service, time became critical . . . Most partners didn’t reveal they were behind schedule.”
FINANCIAL IMPACT OF THE BANKRUPTCY
At the time of the bankruptcy, equity investments in Iridium totaled approximately $2 billion. Most analysts, however, considered the stock worthless. Iridium’s stock price, which had IPOed at $20 per share in June 1997, and reached an all time high of $72.19 in May 1998, had plummeted to $3.06 per share by the time Iridium declared bankruptcy in August 1999. Moreover, the NASDAQ exchange reacted to the bankruptcy news by immediately halting trading of the stock, and actually delisted Iridium in November 1999. Iridium’s partners—who had also made investments by building ground stations, assembling management teams, and marketing Iridium services—were left with little to show for their equity. Iridium’s bondholders didn’t fare much better than its equity holders. After Iridium declared bankruptcy, its $1.5 billion in bonds were trading for around 15 cents to the dollar as the company entered restructuring talks with its creditors.
WHAT REALLY WENT WRONG?
Iridium will go down in history as one of the most significant business failures of the 1990s. That its technology was breathtakingly elegant and innovative is without question. Indeed, Motorola and Iridium leaders showed great vision in directing the development and launch of an incredibly complex constellation of What Really Went Wrong?
satellites. Equally as amazing, however, was the manner in which these same leaders led Iridium into bankruptcy by supporting an untenable business plan.
Over the past several years, there have been perhaps thousands of articles written about Iridium’s failure to attract customers and its resulting bankruptcy. Conventional wisdom often argues that Iridium was simply caught off guard by the spread of terrestrial cellular. By focusing almost strictly on what happened, such an analysis provides little in the way of valuable learning. A more interesting question is why Iridium’s failure happened—namely, why the company continued to press forward with an increasingly flawed business plan.
Three forces combined to create Iridium’s business failure. First, an “escalating commitment,” particularly among Motorola executives who pushed the project forward in spite of known and potentially fatal technology and market problems. Second, for personal and professional reasons Iridium’s CEO was unwilling to cut losses and abandon the project. And third, Iridium’s board was structured in a way that prevented it from performing its role of corporate governance.
Problem 1: Escalating Commitment. During the 11 years that passed between
Indium’s initial concept to its actual development, its business plan eroded. First, the gradual build-out of cellular dramatically shrank Iridium’s target market— international executives who regularly traveled to areas not covered by terrestrial cellular. Second, it became apparent over time that Iridium’s phones would have significant design, operational, and cost problems that would further limit usage.
Motorola’s decision to push Iridium forward in spite of a deeply flawed business plan is a classic example of the pitfalls of “escalating commitment.” The theory behind escalating commitment is based in part on the “sunk cost fallacy”—making decisions based on the size of previous investments rather than on the size of the expected return. People tend to escalate their commitment to a project when they (a) believe that future gains are available, (b) believe they can turn a project around, (c) are publicly committed or identified with the project, and (d) can recover a large part of their investment if the project fails.
Motorola’s involvement in the Iridium Project met all four of these conditions. In spite of known problems, top executives maintained blind faith in Iridium. To say that Iridium’s top management was unaware of Iridium’s potential problems would be wholly inaccurate. In fact, Iridium’s prospectus written in 1998 listed 25 full pages of risks including:
During Iridium’s long concept-to-development time, there is little evidence to suggest that Motorola or Iridium made any appreciable progress in addressing any of these risks. Yet Iridium went forward, single-mindedly concentrating on satellite design and launch while discounting the challenges in sales and marketing the phones. The belief that innovative technology would eventually attract customers, in fact, was deeply ingrained in Motorola’s culture.
Indeed, Motorola’s history was replete with examples of spectacular innovations that had brought the company success and notoriety. In the 1930s, Paul Gavin developed the first affordable car radio. In the 1940s, Motorola rose to preeminence when it developed the first handheld two-way radio, which was used by the Army Signal Corps during World War II. In the 1950s, Motorola manufactured the first portable television sets. In the 1969, Neil Armstrong’s first words from the Moon were sent by a transponder designed and manufactured by the company. In the 1970s and 1980s, Motorola enjoyed success by developing and manufacturing microprocessors and cellular phones.
By the time it developed the concept for Iridium in the early 1990s, Motorola had experienced over 60 years of success in bringing often startling new technology to consumers around the world. Out of this success, however, came a certain arrogance and biased faith in the company’s own technology. Just as Motorola believed in the mid-1990s that cellular customers would be slow to switch from Motorola’s analog phones to digital phones produced by Ericsson and Nokia, their faith in Iridium and its technology was unshakable.
Staiano became CEO of Iridium in late 1996—before the company had launched most of its satellites. During his previous tenure with Motorola, Staiano had developed a reputation as intimidating and demanding—imposing in both stature, at 6 feet 4 inches, and in temperament. Staiano combined his leadership style with an old Motorola ethic that argued leaders had a responsibility to support their projects. Staiano also had significant financial incentives to push the project forward, rather than cutting losses and moving on. In both 1997 and 1998, he received 750,000 Iridium stock options that vested over a 5-year period. Indeed, this fact didn’t escape Staiano’s attention when he took the CEO position in late 1996, stating: “If I can make Indium’s dream come true, I’ll make a significant amount of money.”
Ironically, the demanding leadership style, commitment to the project at hand, and financial incentives that made Ed Staiano such an attractive leader for a startup company such as Iridium turned out to be a double-edged sword. Indeed, Lessons Learned
these same characteristics also made him unwilling to abandon a project with a failed business plan and obsolete technology.
Problem 3: Indium’s Board Did Not Provide Adequate Corporate Governance.
In 1997, Iridium’s board had 28 directors—27 of whom were either Iridium employees or directors designated by Iridium’s partners. The composition, not to mention size, of Iridium’s board created two major problems. First, the board lacked the insight of outside directors who could have provided a diversity of expertise and objective viewpoints. Second, the fact that most of the board was comprised of partner appointees made it difficult for Iridium to apply pressure to its partners in key situations—such as when many partners were slow to set up the necessary sales and marketing infrastructure prior to service launch. In the end, Iridium’s board failed to provide proper corporate oversight and limited Iridium’s ability to work with its partners effectively.
Projects with long concept-to-development times pose unique problems for executives. These projects may seem like good investments during initial concept development; but by the time the actual product or service comes on line, both the competitive landscape and the company’s ability to provide the service or product have often changed significantly.
To deal with long concept-to-development times, executives should evaluate these projects as real options. A simple model would be a two-stage project. The first stage is strategic in nature and provides the opportunity for a further investment and increased return in the second stage. When the initial stage is complete, however, the company must reevaluate the expected return of future investments based on a better understanding of the product/service and the competitive landscape.
Iridium is a textbook example of a project that would have benefited from this type of analysis. The Iridium Project itself essentially consisted of two stages. During stage one (1987–1996), Motorola developed the technology behind Iridium. During stage two (1996–1999), Motorola built and launched the satellites—and the majority of Iridium’s costs occurred during this part of the project.
Looking back, it would be unfair to assert that the initial decision to invest in R&D for Iridium was a mistake. In the late 1980s, Iridium appeared to have a sound business plan. Travel among business executives was increasing, and terrestrial cellular networks didn’t cover many of their destinations. It was certainly not unreasonable to foresee a large demand for a wireless phone that had no geographic boundaries. In turn, the investment in R&D was reasonable as it provided the option to deploy (or not deploy) the complex Iridium satellite system 9 years later.
By 1996, however, when Iridium had to make the decision of whether to invest in building and launching satellites, much had changed. Not only had the growth in cellular networks drastically eroded Iridium’s target market, but Iridium’s own technology was never able to overcome key design, cost, and operational problems. Put simply, Iridium didn’t have a viable business plan. Armed with this additional insight, a reasonable evaluation of the project would have precluded further investment.
The key to using the option value approach is to include it in the business plan. Specifically, executives must specify a priori when they will reevaluate the project and its merits. During this evaluation, the company should objectively evaluate updated market data and its own ability to satisfy changing customer demands. The board of directors plays a key role in this process by making sure that inertia doesn’t carry a failed project beyond its useful life. This is particularly important when company executives have ancillary reasons, such as concerns about personal reputation or compensation, to press forward in spite of a flawed business plan.
Top executives were publicly committed to, and identified with, Iridium. Just as important as its financial investment in Iridium was Motorola’s psychological investment in the project. Motorola’s chairmen, Robert Galvin and later his son Christopher Galvin, publicly expressed support for Iridium and looked to it as an example of Motorola’s technological might. Indeed, it was Robert Galvin, Motorola’s chairman at the time, who first gave Bary Bertiger approval to go ahead with Iridium, after Bertiger’s superiors had rejected the project as being too costly. In the end, both Galvins staked much of Motorola’s reputation on Iridium’s success, and the project provided Motorola and the rest of its partners with a great deal of cachet.
Motorola did gain important benefits from its relationship with Iridium. In fact, Motorola signed $6.6 billion in contracts to design, launch, and operate Iridium’s Lessons Learned
66 satellites and manufacture a portion of its handsets. David Copperstein of Forrester Research described Motorola’s deal with Iridium as “a pretty crafty way of creating a no-lose situation.” Other analysts were less complimentary: “That contract [Motorola’s $50 million a month agreement with Iridium to provide operational satellite support] is absurdly lucrative for Motorola,” said Armand Mussey, an analyst who followed the industry for Bank of America Securities, “Iridium needs to cut that by half.”
These contracts—while lucrative—also gave Motorola an incentive to push Iridium forward regardless of its business plan. Even if Iridium failed, Motorola would still generate significant new revenues along the way. In quantifying the importance of Motorola’s contracts with Iridium, in May 1999 Wojtek Uzdelewicz of SG Cowen estimated that Motorola had already earned and collected $750 million in profits from its dealings with the company. Based on these offsetting profits, he placed Motorola’s total exposure in Iridium to be between $1.0 and $1.15 billion—much less than many observers realized.
Further, Iridium would ultimately expose Motorola to developing satellite technology and the patent protection that came with it. This exposure came at a time when Motorola was interested in entering the satellite communications industry beyond Iridium, in projects such as Craig McCaw’s Teledesic—a $9 billion project consisting of a complex constellation of LEO satellites designed to provide global high-speed Internet access.
In an era where executive compensation is dominated by stock options, the Iridium story should give pause to those who see only the benefits of optionsbased pay. Financial incentives are extremely powerful, and companies that rely on them for motivation must be particularly careful to consider both intended and unintended consequences. Would CEO Staiano have been more attentive to the numerous warning signs with Iridium if stock options didn’t play such a large role in his compensation package? The heavy emphasis on options gave Staiano an incentive to persist with the Iridium strategy; it was the only opportunity he had to make the options pay.
The lessons of the board of directors at Iridium are just as stark. Surely few boards can operate with 28 members, most representing different constituencies surely holding different goals. That all but one board member was a member of the Iridium consortium similarly speaks volumes about the vigilance of the board in fulfilling its oversight function. Actually, this type of board, consisting as it does of representatives of investors, is becoming more common in high-tech startups. Companies such as General Magic, Excite At Home, and Net2Phone have all had multiple investors, typically represented on the board and not always agreeing on strategic direction. In fact, General Magic’s development of a personal digital assistant was severely hampered by its dependence on investors such as Apple, Sony, IBM, and AT&T. With Iridium, the magnitude of the ancillary contractual benefits Motorola derived from Iridium appear rather out-sized given Iridium’s financial condition. An effective board should be simultaneously vigilant and supportive, a tall order for an insider-dominated, multiple-investor board.
What is fascinating about studying cases such as Iridium is that what look like seemingly incomprehensible blunders are really windows into the world of managerial decision-making, warts and all. In-depth examinations of strategy in action can highlight how such processes as escalating commitment are real drivers of managerial action. When organizations stumble, observers often wonder why the company, or the top management, did something so “dumb.” Much more challenging is to start the analysis by assuming that management is both competent and intelligent and then ask, why did it stumble? The answers one gets with this approach tend to be at once both more interesting and revealing. Students of strategy and organization can surely benefit from such a probing analysis.
 Bird, p. 37.
 Bruce Gerding, “Personal Communications via Satellite: An Overview,” Telecommunications, vol. 30, no. 2, February 1996, pp. 35, 77.
 David S. Bennahum, “The United Nations of Iridium,” Wired, issue 6.10, October 1998, p. 194. 7Quentin Hardy, “How a Wife’s Question Led Motorola to Chase a Global Cell-Phone Plan,” Wall Street Journal (Eastern edition), New York, December 16, 1996, p. A1.
 Joe Flower, “Iridium,” Wired, issue 1.05, November, 1993.
 Bennahum,1998, p. 136.
 See note 10.
 Peter Grams and Patrick Zerbib, “Caring for Customers in a Global Marketplace,” Satellite Communications, October 1998, p. 25.
 Isabelle Royer, “Why Bad Projects Are So Hard to Kill,” Harvard Business Review, February 2003, p.11: Copyright © 2003 by the Harvard Business School Publishing Corporation. All rights reserved.
 David Davis, “New Projects: Beware of False Economics,” Harvard Business Review, March–April 1985, pp.100–101. Copyright © 1985 by the President and Fellows of Harvard College. All rights reserved.
 John J. Keller, “Telecommunications: Phone Space Race Has Fortune at Stake,” Wall Street Journal (Eastern edition), New York, January 18, 1993, p. B1.
 Jeff Cole, “McDonnell Douglas Said to Get Contract to Launch 40 Satellites for Iridium Plan,” Wall Street Journal (Eastern edition), New York, April 12, 1994, p. A4.
 Quentin Hardy, “Iridium Pulls $300 Million Bond Offer; Analysts Cite Concerns about Projects,” Wall Street Journal (Eastern edition), New York, September 22, 1995, p. A5.
 Quentin Hardy, “Motorola is Plotting New Satellite Project—M-Star Would Be Faster Than the Iridium System, Pitched to Global Firms,” Wall Street Journal (Eastern edition), New York, October 14, 1996, p. B4.
 Quentin Hardy, “Staiano Is Leaving Motorola to Lead Firm’s Iridium Global Satellite Project,” Wall Street Journal (Eastern edition), New York, December 10, 1996, p. B8. 20Bennahum, 1998.
 Leslie Cauley, “Losses in Space—Iridium’s Downfall: The Marketing Took a Back Seat to Science—Motorola and Partners Spent Billions on Satellite Links for a Phone Few Wanted,” Wall Street Journal (Eastern edition), New York, August 18, 1999, p. A1.
 Excerpts from the Iridium press release, November 1, 1998.
 Excerpts from the Iridium conference call, January 25, 1999.
 See note 23.
 James Surowieckipp, “The Latest Satellite Startup Lifts Off. Will It Too Explode?” Fortune Magazine, October 25, 1999, pp. 237–254.
 Iridium World Communications Ltd., 1998 Annual Report.
 Total system subscribers include users of Iridium’s phone, fax, and paging services.
 Carleen Hawn, “High Wireless Act,” Forbes, June 14, 1999, pp. 60–62.
 Hawn, 1999.
 Leslie Cauley, “Losses in Space—Iridium’s Downfall: The Marketing Took a Back Seat to Science,” Wall Street Journal (Eastern edition), New York, August 18, 1999, p. A1.
 Stephanie Paterik, “Iridium Alive and Well,” The Arizona Republic, April 27, 2005, p. D5. 33Quentin Hardy, “Surviving Iridium,” Forbes, September 6, 1999, pp. 216–217.
 “Craig McCaw Plans Cash Infusion to Support Cash-Hungry Iridium,” Wall Street Journal (Eastern edition), New York, February 7, 2000, p.1.
 “Iridium Set to Get $75 Million from Investors Led by McCaw,” Wall Street Journal (Eastern edition), New York, February 10, 2000, p.1.
 Scott Thurm, “Motorola Inc., McCaw Shift Iridium Tactics,” Wall Street Journal (Eastern edition), New York, February 18, 2000, p.1.
 ”DoD Awards $72 Million to Revamp Iridium,” Satellite Today. Potomac: December 7, 2000, vol.3, iss. 227, p. 1.
 Stephanie Paterik, “Iridium Alive and Well,” The Arizona Republic, April 27, 2005.
 Paterik, 2005.
 Iridium Press Release, February 6, 2006.
 Adapted from Reena Jana, “Companies Known for Inventive Tech Were Dubbed the Next Big Thing and Then Disappeared. Now They’re Back and Growing,” Business Week, Innovation, April 10, 2007.
 Sydney Finkelstein and Shade H. Sanford, “Learning from Corporate Mistakes: The Rise and Fall of Iridium,” Organizational Dynamics, vol. 29, no. 2, 2000, pp. 138–148. © 2000 by Elsevier Sciences, Inc. Reproduced by permission.
Health Care Partners, Inc.
Health Care Partners (HCP) was a forty-year-old company providing health care benefits for large corporations. In order to keep health care costs down for its clients, HCP needed to get a large group of physicians and health care providers in the group that were willing to accept the cost reimbursement rates established by HCP. HCP provided reimbursement rates that were in line with its competitors. While HCP had some success in getting service providers into its network, there was still some resistance from several hospitals and physicians to join the network of providers because HCP had a reputation for reimbursing service providers slowly.
In order to pay service providers quicker, HCP had to modernize its operations and eliminate a lot of the paperwork that generated delays in payments. HCP upgraded its computers quickly. But the real problem was software. There was no software in the marketplace readily available to satisfy the needs of HCP.
HCP hired a software development company, SoftSmart, to assist its IT personnel in the development of the package. SoftSmart was provided with offices for onsite personnel on the same floor as HCP’s IT personnel. HCP had budgeted $15 million for the entire project, entitled QuickPay, and had promised all physicians and hospitals in its network that the system would be up and running in a year or less.
©2010 by Harold Kerzner. Reproduced by permission. All rights reserved.
FIRST QUARTERLY REVIEW MEETING
In the first quarterly review meeting, which was attended by only HCP personnel, Paul Harris, the CIO, stated how furious he was:
Why can’t I get a straight answer from anyone on the status of the QuickPay Project? We’re spending $15 million and nobody seems to know what’s happening. Whenever I ask a question, it appears that all I get in response is bad news. Why aren’t there any metrics for me to look at each week or each month?
Since the project began about three months ago, I have seen requests for more that 200 scope changes. Now I’m told that we will probably be missing deadlines and the schedule slippages cannot be corrected. We have escalating costs because of the scope creep and it looks like we’ll have some deterioration in value expected for our clients.
Evelyn Williams, the project manager for HCP, spoke up:
When we hired SoftSmart, we gave them a fixed price contract. We had no idea how many scope changes they wanted, but we assumed that there would be a small number. We were a little naïve. Last week, when we asked them for their position on the status of their work, they said that they cannot provide us with detailed status information because they say that it depends on the number of scope changes that we approve. Their schedules keep changing.
Paul Harris was furious. It appeared that the company would be spending significantly more than $15 million and he could not get metrics, schedules, or effective status reporting. This project had the potential to be a colossal disaster.
Paul demanded that the company now have monthly rather than quarterly review meeting with him and possibly other senior management personnel. Paul was convinced that everyone understood what had to be done, but he was equally unsure as to whether they would do it.
REVIEW MEETING AT END OF MONTH 4
Paul Harris was still quite unhappy after seeing the data in the review meeting. There were schedules and metrics. During the briefing, Paul was told that work was progressing, but not as fast as originally hoped for. However, the metrics provided no useful information and the schedules had a series of footnotes at various locations stating dependencies on the approval of various scope changes. Once again, Harris found it difficult to determine the true status of the project.
Evelyn Williams, the project manager for HCP, spoke up again:
We’re making progress in status reporting but not as fast as I would have liked. Some of the team members from SoftSmart are reluctant to provide us with good metrics. They tell us that they simply do not believe in the use of metrics, probably because they are afraid of what the metrics might reveal. That’s why they often select the easiest metrics to report or those that provide the least amount of information. Some of our own personnel are infatuated with metrics and we simply cannot afford to create all of the metrics that these people desire. I’m not sure right now which way we should go or what would be a reasonable compromise. To make matters worse, we have lost some of our key personnel to other projects.
There was now no question in Paul’s mind that things were not going as planned. The morale of the team was poor; key personnel had left the project, probably by choice; and status reporting was unacceptable. SoftSmart was probably taking advantage of HCP by pushing through questionable but profitable scope changes and the end date would most likely slip. The decision was clear; there was a definite need for a health check on the project.
Several questions had to be answered before officially conducting the health check. First, should the health check be performed using internal personnel such as representatives from the project management office (PMO)? The project manager would most certainly not be the person allowed to perform the health check. Using PMO personnel is an option, but they may have friendships and loyalties to some of the people on the project team and may not be honest in their conclusions as to the real status and health of the project. External facilitators may be the best choice provided they can operate free of politics and create an environment such that people will feel free to vent their personal feelings. They also bring to the table experience in conducting health check in other companies.
The second question is whether the interviewees will be honest in their responses to the health check facilitators? Paul believed that the personnel at HCP would be honest. However, the real issue may be with SoftSmart. HCP may not be able to get SoftSmart to agree to the interviews and, even if the interviews were conducted, SoftSmart personnel would most likely not provide honest responses. Therefore, it would have to be a health check at HCP only.
Third, Harris was unsure as to how other executives at HCP would respond when hearing the truth about the QuickPay Project. The results of the health check could surface other issues previously hidden. This could make the situation worse than it is already. People could lose their jobs or be demoted. However, there could also be good news and the early detection of problems that could have led to disasters later on.
Harris concluded that there was really no choice: A health check must be conducted. HCP must know the true status. HCP must identify issues early such that sufficient time exists for corrective action.
Harris called an emergency meeting of the QuickPay Project team and asked SoftSmart to be present as well. When informed that he was authorizing an outside company to come in and conduct a health check, several of the team members expressed their dissatisfaction. One team member argued that outside resources do not understand the HCP culture or the project and that this would be a waste of time. Another team member argued that the project was already in financial distress and the cost of the health check would make matters worse. A third team member asserted that critical resources would be tied up in interviews. SoftSmart argued that, by the time the results of the health check are known, it may be too late to make changes because of the ongoing scope changes that are occurring on the project. Harris held his ground and stated emphatically that the health check would be performed and that everyone would be expected to support the company conducting the health check.
HEALTH CHECK. . . .
HCP hired a company, Pegasus Consulting, which had experience in health checks on IT projects and also some experience with hospitals and the health care profession. An agreement was reached that the health check would be completed within three weeks, just prior to the project review meeting scheduled for the end of the fifth month of the QuickPay Project.
Pegasus spent part of the first week reviewing the business case for the project and the project’s history over the past four months. During the remainder of the first week and all of the second week, Pegasus interviewed project personnel from HCP to discover the facts. The interview sessions went well and the interviewees were quite honest in their opinion on the status of the project and what needed to be done to correct the deteriorating situation. A few of the on-site representatives from SoftSmart were also interviewed, but Pegasus believed that their contributions to the health check were meaningless.
By the end of the third week, Pegasus had prepared its report and was ready to brief Harris on the findings. At the briefing meeting, a spokesperson for Pegasus made the following statements:
There are several issues, but the most critical one is the schedule. It is our opinion that the project will be at least three months late. We did a root cause analysis and discovered the following:
There are opportunities for some corrective action. Included in our report is a fix-it plan that we believe will work. However, even with the implementation of the fix-it plan, the project will still be about three months late.”
Paul Harris did not seem surprised with the findings of the health check. He read the final report and believed that the recommended fix-it plan could work. But now Paul had to prepare for two more meetings in which he was expected to report on the findings of the health check: an executive staff meeting and the fivemonth QuickPay Project review meeting.
McRoy Aerospace was a highly profitable company building cargo planes and refueling tankers for the armed forces. It had been doing this for more than fifty years and was highly successful. But because of a downturn in the government’s spending on these types of planes, McRoy decided to enter the commercial aviation aircraft business, specifically wide-body planes that would seat up to 400 passengers, and compete head on with Boeing and Airbus Industries.
During the design phase, McRoy found that the majority of the commercial airlines would consider purchasing its plane provided that the costs were lower than the other aircraft manufacturers. While the actual purchase price of the plane was a consideration for the buyers, the greater interest was in the life-cycle cost of maintaining the operational readiness of the aircraft, specifically the maintenance costs.
Operations and support costs were a considerable expense and maintenance requirements were regulated by the government for safety reasons. The airlines make money when the planes are in the air rather than sitting in a maintenance hangar. Each maintenance depot maintained an inventory of spare parts so that, if a part did not function properly, the part could be removed and replaced with a new part. The damaged part would be sent to the manufacturer for repairs or replacement. Inventory costs could be significant but were considered a necessary expense to keep the planes flying.
One of the issues facing McRoy was the mechanisms for the eight doors on the aircraft. Each pair of doors had their own mechanisms which appeared to be restricted by their location in the plane. If McRoy could come up with a single design mechanism for all four pairs of doors, it would significantly lower the inventory costs for the airlines as well as the necessity to train mechanics on one set of mechanisms rather than four. On the cargo planes and refueling tankers, each pair of doors had a unique mechanism. For commercial aircrafts, finding one design for all doors would be challenging.
Mark Wilson, One of the department managers at McRoy’s design center, assigned Jack, the best person he could think of to work on this extremely challenging project. If anyone could accomplish it, it was Jack. If Jack could not do it, Mark sincerely believed it could not be done.
The successful completion of this project would be seen as a value-added opportunity for McRoy’s customers and could make a tremendous difference from a cost and efficiency standpoint. McRoy would be seen as an industry leader in life-cycle costing, and this could make the difference in getting buyers to purchase commercial planes from McRoy Aerospace.
The project was to design an opening/closing mechanism that was the same for all of the doors. Until now, each door could have a different set of open/close mechanisms, which made the design, manufacturing, maintenance, and installation processes more complex, cumbersome, and costly.
Without a doubt, Jack was the best—and probably the only—person to make this happen even though the equipment engineers and designers all agreed that it could not be done. Mark put all of his cards on the table when he presented the challenge to Jack. He told him wholeheartedly that his only hope was for Jack to take on this project and explore it from every possible, out-of-the-box angle he could think of. But Jack said right off the bat that this may not be possible. Mark was not happy hearing Jack say this right away, but he knew Jack would do his best.
Jack spent two months looking at the problem and simply could not come up with the solution needed. Jack decided to inform Mark that a solution was not possible. Both Jack and Mark were disappointed that a solution could not be found.
“I know you’re the best, Jack,” stated Mark. “I can’t imagine anyone else even coming close to solving this critical problem. I know you put forth your best effort and the problem was just too much of a challenge. Thanks for trying. But if I had to choose one of your co-workers to take another look at this project, who might have even half a chance of making it happen? Who would you suggest? I just want to make sure that we have left no stone unturned,” he said rather glumly.
Mark’s words caught Jack by surprise. Jack thought for a moment and you could practically see the wheels turning in his mind. Was Jack thinking about who could take this project on and waste more time trying to find a solution? No, Jack’s wheels were turning on the subject of the challenging problem itself. A glimmer of an idea whisked through his brain and he said, “Can you give me a few days to think about some things, Mark?” he asked pensively.
Mark had to keep the little glimmer of a smile from erupting full force on his face. “Sure, Jack,” he said. “Like I said before, if anyone can do it, it’s you. Take all the time you need.”
©2010 by Harold Kerzner. Reproduced by permission. All rights reserved.
A few weeks later, the problem was solved and Jack’s reputation rose to even higher heights than before.
The Poor Worker
Paula, the project manager, was reasonably happy the way that work was progressing on the project. The only issue was the work being done by Frank. Paula knew from the start of the project that Frank was a mediocre employee and often regarded as a trouble-maker. The tasks that Frank was expected to perform were not overly complex and the line manager assured Paula during the staffing function that Frank could do the job. The line manager also informed Paula that Frank demonstrated behavioral issues on other projects and sometimes had to be removed from the project. Frank was a chronic complainer and found fault with everything and everybody. But the line manager also assured Paula that Frank’s attitude was changing and that the line manager would get actively involved if any of these issues began to surface on Paula’s project. Reluctantly, Paula agreed to allow Frank to be assigned to her project.
Unfortunately, Frank’s work on the project was not being performed according to Paula’s standards. Paula had told Frank on more than one occasion what she expected from him, but Frank persisted in doing his own thing. Paula was now convinced that the situation was getting worse. Frank’s work packages were coming in late and sometimes over budget. Frank continuously criticized Paula’s performance as a project manager and Frank’s attitude was beginning to affect the performance of some of the other team members. Frank was lowering the morale of the team. It was obvious that Paula had to take some action.
The Prima Donna
Ben was placed in charge of a one-year project. Several of the work packages had to be accomplished by the Mechanical Engineering Department and required three people to be assigned full time for the duration of the project. When the project was originally proposed, the Mechanical Engineering Department manager estimated that he would assign three of his grade 7 employees to do the job. Unfortunately, the start date of the project was delayed by three months and the department manager was forced to assign the resources he planned to use on another project. The resources that would be available for Ben’s project at the new starting date were two grade 6’s and a grade 9.
The department manager assured Ben that these three employees could adequately perform the required work and that Ben would have these three employees full time for the duration of the project. Furthermore, if any problems occurred, the department manager made it clear to Ben that he personally would get involved to make sure that the work packages and deliverables were completed correctly.
Ben did not know any of the three employees personally. But since a grade 9 was considered as a senior subject matter expert pay grade, Ben made the grade 9 the lead engineer representing his department on Ben’s project. It was common
©2010 by Harold Kerzner. Reproduced by permission. All rights reserved.
practice for the senior-most person assigned from each department to act as the lead and even as an assistant project manager. The lead was often allowed to interface with the customers at information exchange meetings.
By the end of the first month of the project, work was progressing as planned. Although most of the team seemed happy to be assigned to the project and team morale was high, the two grade 6 team members in the Mechanical Engineering Department were disenchanted with the project. Ben interviewed the two grade 6 employees to see why they were somewhat unhappy. One of the two employees stated:
The grade 9 wants to do everything himself. He simply does not trust us. Every time we use certain equations to come up with a solution, he must review everything we did in microscopic detail. He has to approve everything. The only time he does not micromanage us is when we have to make copies of reports. We do not feel that we are part of the team.
Ben was unsure how to handle the situation. Resources are assigned by the department managers and usually cannot be removed from a project without the permission of the department managers. Ben met with the Mechanical Engineering Department manager, who stated:
The grade 9 that I assigned is probably the best worker in my department. Unfortunately, he’s a prima donna. He trusts nobody else’s numbers or equations other than his own. Whenever co-workers perform work, he feels obligated to review everything that they have done. Whenever possible, I try to assign him to one-person activities so that he will not have to interface with anyone. But I have no other one-person assignments right now, which is why I assigned him to your project. I was hoping he would change his ways and work as a real team member with the two grade 6 workers, but I guess not. Don’t worry about it. The work will get done, and get done right. We’ll just have to allow the two grade 6 employees to be unhappy for a little while.
Ben understood what the department manager said but was not happy about the situation. Forcing the grade 9 to be removed could result in the assignment of someone with lesser capabilities, and this could impact the quality of the deliverables from the Mechanical Engineering Department. Leaving the grade 9 in place for the duration of the project will alienate the two grade 6 employees and their frustration and morale issues could infect other team members.
The Team Meeting
Every project team has team meetings. The hard part is deciding when during the day to have the team meeting.
KNOW YOUR ENERGY CYCLE
Vince had been a “morning person” ever since graduating from college. He enjoyed getting up early. He knew his own energy cycle and the fact that he was obviously more productive in the morning than in the afternoon.
Vince would come into work at 6:00 a.m., 2 hours before the normal work force would show up. Between 6:00 a.m. and noon, Vince would keep his office door closed and often would not answer the phone. This prevented people from robbing Vince of his most productive time. Vince considered time robbers such as unnecessary phone calls lethal to the success of the project. This gave Vince 6 hours of productive time each day to do the necessary project work. After lunch, Vince would open his office door and anyone could then talk with him.
A TOUGH DECISION
Vince’s energy cycle worked well, at least for Vince. But Vince had just become the project manager on a large project. Vince knew that he may have to sacrifice some of his precious morning time for team meetings. It was customary for each project team to have a weekly team meeting, and most project team meetings seemed to be held in the morning.
Initially, Vince decided to go against tradition and hold team meetings between 2:00 and 3:00 p.m. This would allow Vince to keep his precious morning time for his own productive work. Vince was somewhat disturbed when there was very little discussion on some of the critical issues and it appeared that people were looking at their watches. Finally, Vince understood the problem. A large portion of Vince’s team members were manufacturing personnel that started work as early as 5:00 a.m. The manufacturing personnel were ready to go home at 2:00 p.m. and were tired.
The following week Vince changed the team meeting time to 11:00 to 12:00 a.m. It was evident to Vince that he had to sacrifice some of his morning time. But once again, during the team meetings there really wasn’t very much discussion about some of the critical issues on the project and the manufacturing personnel were looking at their watches. Vince was disappointed and, as he exited the conference room, one of the manufacturing personnel commented to Vince, “Don’t you know that the manufacturing people usually go to lunch around 11:00 a.m.?”
Vince came up with a plan for the next team meeting. He sent out e-mails to all of the team members stating that the team meeting would be at 11:00 to 12:00 noon as before but the project would pick up the cost for providing lunch in the form of pizzas and salads. Much to Vince’s surprise, this worked well. The atmosphere in the team meeting improved significantly. There were meaningful discussions and decisions were being made instead of creating action items for future team meetings. It suddenly became an informal rather than a formal team meeting.
While Vince’s project could certainly incur the cost of pizzas, salads, and soft drinks for team meetings, this might set a bad precedent if this would happen at each team meeting. At the next team meeting, the team decided that it would be nice if this could happen once or twice a month. For the other team meetings, it was decided to leave the time for the team meetings the same at 11:00 to 12:00 noon but they would be “brown bag” team meetings where the team members would bring their lunches and the project would provide only the soft drinks and perhaps some cookies or brownies.
THE TEAM MEETING
The Management Control Freak
The company hired a new vice president for the Engineering Department, Richard Cramer. Unlike his predecessor, Richard ruled with an iron hand and was a true micromanager. This played havoc with the project managers in Engineering because Richard wanted to be involved in all decisions, regardless of how small.
WHAT TO DO
Anne was an experienced project manager who had been with the company for more than twenty years. She had a reputation for being an excellent project manager and people wanted to work on her projects. She knew how to get the most out of her team and delegated as much decision-making as possible to her team members. Her people skills were second to none.
A few months before Richard Cramer was hired Anne was assigned to a twoyear project for one of the company’s most important clients. Anne had worked on projects for this client previously and the results were well received by the client. The client actually requested that Anne be assigned to this project.
Almost all of Anne’s team members had worked for her before. Some of the team members had even asked to work for her on this project. Anne knew some of the people personally and trusted their decision-making skills. Having people assigned that have worked with you previously is certainly considered a plus.
Work progressed smoothly until about the third week after Richard Cramer came on board. In a meeting with Anne, Richard commented:
I have established a policy that I will be the project sponsor for all projects where the project managers report to someone in Engineering. I know that the Vice President for Marketing had been your sponsor for previous projects with this client, but all of that will now change. I have talked with the Vice President for Marketing and he understands that I will now be your sponsor. I just cannot allow anyone from outside of Engineering [to] be a sponsor of a project that involves critical engineering decisions and where the project managers come from Engineering. So Anne, I will be your sponsor from now on and I want you [to] talk to my secretary and set up weekly briefings for me on the status of your project. This is how I did it in my previous company and it worked quite well.
These comments didn’t please Anne. The vice president for marketing was quite friendly with the client and now things were changing. Anne understood Richard’s reasons for wanting to do this but certainly was not happy about it.
Over the next month, Anne found that her working relationship with Richard was getting progressively worse and it was taking its toll on the project. Richard was usurping Anne’s authority and decision-making. On previous projects, Anne would meet with the sponsor about every two weeks and the meeting would last about 15 minutes. Her meetings with Richard were now weekly and were lasting for more than 1 hour. Richard wanted to see all of the detailed schedules and wanted a signature block for himself on all documents that involved engineering decisions.
There was no question in Anne’s mind that Richard was a true micromanager. At the next full team meeting, some of the workers were complaining that Richard was calling them directly, without going through Anne, and making some decisions that Anne did not know about. The workers were receiving directions from Richard that were in conflict with directions provided by Anne. Anne could tell that morale was low and heard people mumbling about wanting to get off of this project.
At Anne’s next meeting with Richard, she made it quite clear about how upset she was with Richard’s micromanagement of the project and, if this continued, she would have a very unhappy client. Richard again asserted how he had to be involved in all technical decisions and that this was his way of managing. He also stated that, if Anne was unhappy, he could find someone else to take over her job as the project manager.
Something had to be done. This situation could not be allowed to continue without damaging the project further. Anne thought about taking her concerns Questions directly to the president but realized that nothing would probably change. And if that happened, Anne could be worse off.
Anne then came up with a plan. She would allow Richard to micromanage and even help him do so. There was a risk in doing this and Anne could very well lose her job. But she decided to go ahead with her plan. For the next several weeks, Anne and all of the team members refused to make even the smallest decisions themselves. Instead, they brought all of the decisions directly to Richard. Richard was even getting phone calls at home from the team members on weekends, during the dinner hour, late at night, and early Sunday mornings.
Richard was now being swamped with information overload and was spending a large portion of his time making mundane decisions on Anne’s project. In the next team sponsor briefing meeting with Anne, Richard stated:
I guess that you’ve taught me a lesson. “If it’s not broken, then there isn’t any reason to fix it.” I guess that I came across too strong and made things worse. What can we do to repair the damage I may have done?
Anne could not believe that these words were spoken by Richard. Anne was speechless. She thought for a moment and then went over to the white board in Richard’s office. She took a magic marker and drew a vertical line down the center of the board. She put her name to the left of the line and Richard’s name to the right of the line. She then said:
I’m putting my responsibilities as a project manager under my name and I’d like you to put your responsibilities as a sponsor under your name. However, the same responsibility cannot appear under both names.
An hour later, Anne and Richard came to an agreement on what each other’s responsibilities should be. Anne walked out of Richard’s office somewhat relieved that she was still employed.
The Skills Inventory Project
The Riverside Software Group (RSG) was a small software company that specialized in software to support the Human Resources Departments of both large and small corporations. RSG had been in business for more than thirty years and had an excellent reputation and an abundance of repeat business.
In 2011, RSG was awarded a contract from a Fortune 100 company to develop an inventory skills software package. The Fortune 100 company maintained a staff of more than 10,000 project managers worldwide and a total employment of more than 150,000 employees. Although the company sold products and services across the world, it was also marketed as a global business solutions provider. Since most of the work was global, RSG utilized virtual teams on almost all projects. The difficulty was in the creation of the virtual team. Quite often, the project managers had limited knowledge of the capabilities of the employees around the world, and this made it difficult to establish a project team with the best available resources. What was needed was an inventory skills matrix for all employees.
The contract with RSG was not that complex. Whenever the Fortune 100 company would complete a project, either for an external client or one of its worldwide clients, the entire project team would use the software to update their resumes, including the new skills they developed, the chemical or specialized processes they were now familiar with, and whatever additional information would be valuable to their company in determining the best available personnel for the next project. The project team also had to identify in the software program the lessons that were learned on that project, the best practices that were captured, the metrics and key performance indicators that were used, and other such factors that could benefit the company in the future.
RSG saw this as an excellent opportunity. The client had done its homework well and created a detailed requirements package. Neither RSG nor the client expected any significant scope changes since the requirements were reasonably well established. The contract was a firm-fixed-price (FFP) effort of $1.2 million for labor and materials, an additional $150,000 in profit, and with a scheduled completion date of twelve months.
Within the first two months of the project, RSG realized that this software package had tremendous potential and could be sold to many of its clients around the world. RSG estimated that clients would pay at least $75,000 for such a package and also pay additional costs for possible customization. The problem was that the contract with the client was FFP and all of the intellectual property rights stayed with the client.
If RSG agreed to allow the client to sell the package to other customers, RSG would probably have to spend about $10,000 in preliminary customization for each client. Detailed customization would be billed separately to each client. Additional costs, including documentation, packaging, and shipping/handling, would be about $5,000. Therefore, even adding in a small financial reserve of $5,000 as a risk factor for other design contingencies, RSG’s cost per package would be about $20,000 and it could sell for $75,000. Marketing and sales personnel believed that at least 100 of these packages could be sold worldwide.
Given the potential of this effort, the company had to come up with a plan on how they would approach the client and request a change in the contract. The simplest solution would be to make the client a 50–50 partner, but that could create problems with enhancements and upgrades to the package downstream. The second approach would be to see if the client would allow the contract to change to a cost-sharing effort. The profit of $150,000 would be removed from the $1,350,000 contract that now existed, and the remaining question would be the cost-sharing split. Originally, RSG considered proposing a 70–30 or 60–40 spilt with the greater percentage of the cost being paid for by the client. However, to make it attractive to the client, RSG decided to offer the client a 40–60 split with the 60 percent paid for by RSG.
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