Schafer: Shrinking a small firm can be the right plan

Quality Ingredients of Burnsville is just a fraction of the size it was a year ago, but there's nothing amiss. It's smaller today because that was the plan.

It was about a year ago that Quality Ingredients sold by far its biggest business. Since then the management team has been busy getting reacquainted with the much smaller business it kept — and liking what it's learned. A year after the divestiture, CEO Isabelle Day said she wouldn't change a thing.

Because growth is so deeply embedded in the culture of American business, it's important to understand why managers on their way to $75 million in revenue made a good call when the deal left them in charge of a $15 million business.

Selling the biggest part of the company wasn't for the usual reasons. There was, for example, no founder to be bought out. An employee stock ownership plan took care of that years ago.

The company didn't need the money. It had the cash in the bank to fund an expansion at its Burnsville plant even before it proceeded to sell its much larger business in Marshfield, Wis. That's because both businesses made money.

"It's definitely not a story of anything being broken," Day said. "I know a lot of companies, particularly small companies, can get emotionally attached to their businesses, particularly when they are doing well. Why would you ever sell? Well, sometimes it can be the best thing for the business."

Quality Ingredients had the luxury of having options only because the operation had been turned around after Day got there in 2005, when the company was not quite 20 years old.

Day started the turnaround in 2005 inside the four walls of Quality Ingredients' buildings, by improving operations. Her first step was introducing common business measurements into what had been very much a mom-and-pop company.

The performance of the company improved, with both Burnsville and Marshfield, a plant acquired in 1999, turning consistently profitable. But several years ago Day reached the conclusion that the company was really two very different businesses, not one.

The smaller facility in Burnsville was a contract manufacturing operation, making powdered ingredients for customers to precise specifications.

Because the customers continue to own the raw materials, Quality Ingredient's Burnsville "tolling business" is really a service business. Its competitive advantage is built on its expertise in quickly making and delivering small quantities of multiple powdered ingredients, along with customer service.

Marshfield was more of a production operation, of ingredients sold under the Quality Ingredients brand for nondairy creamers and other products. Unlike the growing market opportunity for the Burnsville business, the Marshfield business sold into a market that was growing no faster than the overall economy.

Day and Boyea decided that the Marshfield business would be better off if they struck a deal with the No. 3 player, a private company based in Missouri that operated under the name SensoryEffects.

"People said it feels like we are giving away our child," Day said. "No we were not. We were positioning our child for long-term success. We wanted what was best for that business."

Because Quality Ingredients is owned by employees in an ESOP, the potential sale had to be put to a vote. Management got the overwhelming approval to go ahead with the sale.

Most of the sale proceeds were used to buy back about two thirds of the shares, owned primarily by folks who were going to work for SensoryEffects. Day declined to discuss specifics, but noted that employees in the ESOP in 2005 made more than 10 times their money.

The day after closing, Quality Ingredients had a $15 million a year operation in Burnsville that, as Boyea said, "kind of seemed to be growing on its own without a lot of resources or attention."

Day said she and her colleagues knew their industry had lots of small players splitting the market, but in the past year they've been amazed to encounter competitors they hadn't even heard of before.

Day also said that a year ago she hadn't fully realized just how much innovation was going on in the market. There are lots of upstarts and entrepreneurs, some in food but many others in the market for dietary supplements. Many of the entrepreneurs have backgrounds in food science or marketing and will need the help of Quality Ingredients to get their products manufactured.

As Day talked about the potential for growth, it's clear there's no second divestiture in her plans.

An ESOP-owned company has similar obligations to a public company in that it has to carefully consider a legitimate purchase proposal, and "I actually had somebody put out an offer on the table," she said. "And I said, 'There is no way I can look the employees in the eyes, with all the things we've got going on, and say we would be better off taking it.'

"Given what we believe we can do in this business, why would we give that up?" she added. "It would have to be an incredible offer."