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OPERATIONS

Payback

When Wal-Mart tried to push around Chuck Mitchell's company, GTO, one time too many, he did what few small businesses have dared to do: he fought back.
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Many vendors are willing to take their lumps as the price of doing business with Wal-Mart. The last thing any sane supplier wants is to go head-to-head in court against the world's largest retailer. Then there's Chuck Mitchell

Near the end of his long-awaited meeting at Wal-Mart headquarters, Chuck Mitchell yanked a snapshot out of his briefcase and slid it onto the desk. "All I said was, 'And then there's this," he recalls.

It was a small gesture but a momentous one. Dim as the Polaroid photo was, it was still a bombshell. But Mitchell didn't wave it around like a weapon or a victory flag. He hadn't made the daylong, three-airline trek from Tallahassee, Fla., to tiny Bentonville, Ark., to alienate his company's biggest customer. GTO Inc., the $4-million company he had taken over nine months earlier, depended on the Sam's Club division of Wal-Mart Stores Inc. for 40% of its revenues. "As a company," says Linda Williams, GTO's director of sales, who had accompanied Mitchell on the September 1994 trip, "our priority was definitely to keep Wal-Mart satisfied."

Nothing had been more critical to GTO's success than signing Sam's Club. In 1989, when GTO was just barely two years old, spilling nearly $464,000 of red ink on revenues of just over $1 million, Sam's Club agreed to sell GTO's automatic gate opener. In doing so, it endowed GTO with the credibility to lure other big retailers, such as Home Depot. Feedback from Wal-Mart customers even inspired the company to create its GTO Pro line, aimed at professional installers. In 1993, GTO placed 120th on the Inc. 500, this magazine's ranking of the country's fastest-growing companies. Looking back at what Sam's Club's endorsement had meant to GTO in its early days, Williams says, "As a start-up, you're in heaven."

But by 1994, the relationship between GTO and Sam's Club was heading toward a much more fiery locale.

Which is why Mitchell had traveled to the meeting with Sam's Club hardware buyer Jim Bevis. Mitchell recounts that he waited, while "steaming on a couple of levels" in the hot, unfinished barn that served as a "holding cell" for suppliers, until Bevis showed up for their 8 a.m. appointment 45 minutes late. Once past the small talk, Mitchell began a rehearsed recitation of complaints, all couched in terms of potential remedies that GTO would agree to shoulder. "We went out there with solutions," says Mitchell. "We figured we're littler, so we'll assume the responsibility for making the relationship better."

Mitchell fully expected his most valued customer to address his main gripe: Sam's Club was sending back, as defective, at least 20 gate openers a month. Under its contract GTO had to pay freight costs, ranging from $9 to $40 for each of the 30-pound units returned, plus a 10% handling credit amounting to $36.65. "There are products coming back that are not defective," Mitchell says he told Bevis. "And we need to deal with these." (Bevis declined Inc.'s request for an interview and, in January, left the company.)

Mitchell went on to detail all the steps that GTO would take to help. Some of the gate openers were coming back missing components--often one or both of the handheld transmitters. Since it was much cheaper for GTO to ship out a replacement part than to deal with the return of a whole unit, the company would redesign its packaging, spending $5,000 on new dies so that Sam's Club workers could tell at a glance whether any components were missing. Mitchell even showed Bevis a rough rendering of a revamped box, which had the added benefit of being 20% smaller. It would feature a drawing of all 15 major components and list them all on the outside. And GTO would print its toll-free number on each box, Mitchell volunteered. Good, Bevis suggested, and how about a sticker with the number on the gate opener's control box? Done. Bevis was "real excited," recalls Williams.

But then GTO's president suggested that Sam's Club might make one concession in how much it charged its vendor for returns. Of course, Mitchell quickly reassured Bevis, he wanted Sam's Club to send back anything. And no, he added, he wasn't expecting Sam's Club employees to take time to determine whether the highly mechanical product was truly defective. All he was suggesting was a system that would prevent Sam's Club from charging GTO for nondefective returns. If Sam's Club returned nondefective merchandise, as determined by GTO, it would not get the extra 10% handling credit. As a sweetener, GTO would throw in a 1% credit for Sam's to spend on "customer satisfaction."

Furthermore--and here Mitchell was about to unload the one-two punch that had brought him to Bentonville--GTO would even accept $24,000 as full payment for the $80,000 in improper credits that Wal-Mart had taken so far that year, which GTO had documented.

But before Bevis could react, Mitchell passed him the photo.

On the surface, it looked rather harmless. All it showed was a package of Pampers, spanking clean ones. Absurd as it sounded, Sam's Club had returned the diapers in August 1994 to GTO in an E-Z Gate Opener box, taking a 10% handling credit for them. "Be glad you didn't get 50 more," Mitchell quotes Bevis as saying. To which Mitchell shot back, "Well, Jim, we can't do business in an environment where I have to feel lucky not to get Pampers."

Mitchell remembers Bevis nodding and adding, "I hear what you're saying." Bevis then brought the meeting to a close, asking for a formal proposal. "My understanding was that we had a new understanding," Mitchell says.

Mitchell wouldn't see Bevis again for almost three years. At their next meeting, Mitchell would be accompanied by his lawyer, because by then GTO had sued Wal-Mart for breach of contract. Mitchell's decision to sue his company's largest customer, which, with $138 billion in sales, also just happens to be the largest retailer in the world, sounds irrational. Seasoned vendors to the so-called big boxes--superchains like Wal-Mart--know that dealing with them requires a constant series of compromises and accommodations. They believe such slights and injustices are costs of doing business, not the stuff of litigation.

To nourish their slender profits, the big boxes will charge companies like GTO "indiscriminately," notes Andrew Jassin, a New York City-based consultant to retail suppliers. "If something doesn't sell at the expected rate or the inventory doesn't move, the retailer will inexplicably return the product, and the seller who doesn't fight will be charged."

Yes, fighting is part of the game. But what Mitchell didn't appear to know was that any disagreement is supposed to stop short of mortal combat. A building contractor for 20 years, he had no experience with retailing or manufacturing before he took over GTO, in 1993. Mitchell knew, of course, that suing would be risky, that it would forever alienate Wal-Mart and could even stigmatize GTO as it sought to attract other brand-name retailers. Yet once he came to understand Sam's Club's tactics, he felt there was no choice but a showdown. And despite the risks, he says, "it felt great to be able to kick Wal-Mart in the shins."

Charles Burrell Mitchell III has the high cheekbones of Glen Campbell and the gray mane of Charlie Rich, the country crooner. If his smile appears preternaturally white, that's because those aren't his original-issue teeth. In his freshman year at Florida State University, he crawled inside a heating duct of a chemistry lab. Somehow a solid metal door smashed him squarely in the face, knocking out several front teeth. Why a duct? "It was something I needed to explore," he says by way of explanation.

Mitchell, evidently, has always gone his own way. He built his house with his bare hands back in 1973. That same year he founded Mad Dog Design & Construction Co., a maker of custom houses in Tallahassee, instead of accepting a Wilson fellowship to study for a Ph.D. in American history at Yale. As Mad Dog's president, Mitchell worked to create customer loyalty: he made a point of being the kind of builder who wouldn't clobber customers who wanted an extra door.

Among Mitchell's customers was Lester M. Tabb, a former Wall Street trader who later founded GTO and invited Mitchell to become an investor and board member. The idea for the automatic gate opener came from Wayne A. Payne, an amateur inventor. Now a senior vice-president and chief operations officer at GTO, 43-year-old Payne shares an office with his yellow-headed Amazon parrot, Bubba. Just down the hall Mitchell's brother, John, a vice-president, often works beside his caged, six-foot-long gray rat snake. Phil Wilkins, director of research and development, also has an office mate: his beloved baby boa. Indeed, the menagerie-like atmosphere at GTO reflects Mitchell's unconventional style.

Until 1994, GTO was a money-losing enterprise. But Tabb, a born salesman, stayed upbeat, portraying the gate opener as something that was destined to become as ubiquitous as garage-door openers. Landing Sam's Club in 1989 nonetheless had seemed to fulfill his vision. "Everybody was saying, 'Hey, this could be the account that will put us over the top. We could be a viable company after this," recalls board member Mike Blankenship. "Once you get that kind of account, you really feel you have accomplished something."

Everyone had high hopes that GTO would have the kind of alliance with Wal-Mart that founder Samuel Moore Walton had himself championed. Wal-Mart's vendors were "partners" in Walton's vocabulary. With them, he would write in his memoir, Sam Walton: Made in America, he sought to "sit down...and work out the costs and margins and plan everything together....Then, as long as they are honest with us and try to lower their costs as much as they can, and keep turning out a product that the customers want, we can stay with them." Of course, Wal-Mart also became known for its fierce efficiency, in part by squeezing every cent out of its supply chain. That strategy became especially true at Sam's Club, which must operate on a "very, very low" gross margin to stay competitive with front-runner Costco Cos., according to Maggie Gilliam, a retail consultant who worked as a Wall Street analyst for 35 years.

For Tabb the prospect of having his gate opener on the shelves of many of the Sam's Club stores--now totaling more than 450--potentially meant millions of dollars of business. And by 1992, Sam's Club was snapping up $1 million worth of gate openers. But Tabb didn't feel much like a valued partner.

Payne, among others, had brought to Tabb's attention the problem with returns. "We need to do something," he said. But Tabb, understandably, was cautious about alienating the customer he had worked so hard to bag. A few months into GTO's relationship with Sam's Club, in a letter he fired off on June 18, 1990, Tabb complained of four units that "were obviously not returned under the terms of our vendor agreement." The gate openers had been abused, he wrote--one by a cutting torch, another by submersion in water--and some were missing parts. "We want to emphasize that this is not the first time products have been returned to the factory in this kind of condition," he wrote.

The answer he got back--"Don't do that again," according to Mitchell--was, in spirit, the same reply GTO would receive for the next half a dozen years. Although Tabb didn't do it again, in 1993, shortly before he died, he instructed employees to photograph and test every returned gate opener. Testing could determine, for instance, if the gate opener had been crushed by an impatient driver, fried by lightning, or installed on a gate heavier than the maximum allowance of 350 pounds. It could also show that nothing whatsoever was wrong with the device.

That's a practice that Mitchell continued when he succeeded Tabb as president. (For more on Mitchell's early days as GTO's president, see " Real-World Reengineering," April 1995.) Mitchell was adamant about it. "We weren't going to be a slave to Wal-Mart," he says.

"Due to the differences in business philosophy, Sam's must discontinue the purchase of the E-Z Gate from GTO effective May, 1996." That caustic sentence leaps off the page of a letter that Mitchell received from Thomas J. Sharpe, divisional merchandise manager at Sam's Club. It's one of 3,000 documents in GTO's archives--including photos, test results, and Mitchell's correspondence--that trace the rise and fall of the company's anguished tenure as a Sam's Club supplier.

Once Mitchell returned from his September 1994 trip to Bentonville, he and Bevis became monthly pen pals. A few days after their meeting, he sent a four-page proposal to Sam's Club to open a new chapter in their relationship and remind Bevis of the $24,000 check Mitchell was expecting. Two letters later Mitchell wrote an indignant encore, setting a December 19 deadline for confirmation of payment to come (the claim had risen to $35,986.89, swollen by more "incorrect" returns) and threatening for the first time to sue. "It's been nearly two months and, despite my written requests and our repeated phone calls, we have not heard anything from you regarding these issues," Mitchell wrote. A day after the deadline, a fax arrived at GTO with a copy of Mitchell's letter and Bevis's scrawlings on top: "Linda, we are submitting $35,986.89 for approval to repay this week."

The check actually arrived in March; it was short by $420. "They clipped us for certain credits," Mitchell says.

Throughout 1995 Mitchell assumed that he and Bevis had a new agreement. He submitted quarterly reports to Sam's Club and requested money for returns that he had determined were invalid. The amount would total almost $45,000 for the year. But by mid-1995, Bevis had transferred to another division. His replacement told Williams that he didn't know anything about a new agreement.

So at the start of the new year, Mitchell wrote to the president and CEO of Sam's Club, Joseph Hardin Jr. Once again he reviewed the basis for GTO's burgeoning claim, and he enclosed copies of five previous letters. The letter also alluded to the cache of Polaroids and diagnostic reports that Mitchell had amassed. Not that Mitchell was depending on his stash of evidence to sway Sam's Club; he had significant leverage, he believed. He says that Sam's Club bought the gate openers for $366.50 and sold them for $437, which meant it enjoyed a bulky 19% gross margin on GTO's product. "I knew at some point, when I pushed too hard, they were going to cut me off," he says. That time, he soon learned, was at hand.

It was Sharpe who responded on Hardin's behalf. According to the notes Mitchell took of their February 21 conversation, Sharpe told him that Sam's Club didn't owe GTO any money and any agreement with Bevis was "invalid because he didn't have the authority to negotiate on the part of Sam's." Sharpe would not hear of a new vendor agreement. The two haggled over the definition of defective, with Mitchell citing the inexplicable diaper delivery. Sharpe, however, proposed a few options: why didn't GTO, for example, raise its prices to cover the cost of the returns? As for the agreement, Sharpe told him flat out, "We're going to interpret it the way we interpret it, and if you don't like it, you don't have to sell to Sam's anymore."

What Sharpe suggested--setting a purchase price that covers the cost of returns--is, in fact, what Wal-Mart's vendors typically do, according to Betsy Reithemeyer, a spokesperson for the chain. "It's all part of the negotiations when we're talking to a vendor," she adds. But GTO's days as a Sam's Club vendor were waning after the argument between Mitchell and Sharpe. Three months later, after a further exchange of letters, Mitchell received Sharpe's "Dear John" letter. (Both Sharpe and Hardin have since left Sam's Club. Sharpe couldn't be reached for comment, and Hardin declined a request for an interview.)

Having pushed Sam's Club hard to honor his claim, and then having provoked the retailer to the point of severing their relationship, Mitchell recalls, "I didn't have this big remorse. I had laid the groundwork for this to happen. I had set them up to dump us." And Mitchell already knew his next move: he would sue Wal-Mart. But first he had to persuade his board to go along with it.

The 15-member board "wasn't wild about the idea" of taking on Wal-Mart in court, Mitchell quickly learned. Accountant Benson Skelton, for one, voiced strong doubts about taking on "the Big Gorilla," as everyone routinely referred to Wal-Mart. "I just wanted to make sure we wouldn't be eaten alive by lawyers," says Skelton. Similarly, Mike Blankenship, having run his own pipeline- and road-construction company for 30 years, urged Mitchell to salvage the important relationship. "Anytime you litigate, everybody is in trouble," he now says. In the end the board authorized spending $25,000 to allow the company's attorneys to review the documentation and advise it what to do.

In Mitchell's estimation there was no way GTO could lose a suit. Between 1994 and 1996, as GTO was prepared to document, Sam's Club had sent back 821 gate openers that weren't defective, at least not by any definition that any jury would accept, he believed. The cost of those returns--including crediting Wal-Mart for the purchase price, the freight expense of sending the gate openers back to Tallahassee, and the 10% handling charge--amounted to just over $344,000. About half a dozen times, Sam's Club had returned items that GTO didn't even make, such as car winches and bicycle chains. Twice, Harris Welch, an R&D technician, sliced open boxes to find Genie brand garage-door openers inside. And who could forget the diapers? "It didn't really shock me," says R&D director Phil Wilkins. "We all laughed, and somebody said, 'Look what they sent to us this time."

GTO's lawyer, Michael F. Coppins, pored over the documents for three hours and concurred with Mitchell. "What I saw was a massive effort on the part of GTO to bend over backward, or even further, to accommodate Wal-Mart," he says. "Maybe it's a function of size, but there was almost a refusal on the part of Wal-Mart to take GTO seriously." (Even Jeffrey P. Gill, a lawyer based in Pensacola, Fla., who represented Wal-Mart in the case, would praise the documentation as "very good," adding that GTO's kind of documentation was "not the norm.") Still, Coppins warned that litigating the case could cost GTO as much as $100,000.

Of course, GTO was a less financially potent company without the Sam's Club business, but not by much. By the time the two companies went their separate ways, the account was still worth $800,000 a year, representing 18% of revenues. But Mitchell says the net profit on that business was "pitifully little." To fortify GTO's position, Mitchell had been working for years to diversify GTO's customer base far beyond Sam's Club. He'd worked on boosting the GTO Pro line, offering better service and volume discounts. And he'd added sales-rep companies to push GTO's gate openers into more retail chains. It paid off. In late 1995, GTO signed up another division of Home Depot and won a new customer, Tractor Supply Co., a Nashville-based retailer of farm supplies. "I wanted the comfort of having another large customer," Mitchell explains. "I had to have a rabbit hole before I threw the gauntlet down."

And once Sam's Club cut him off, he wasted no time letting other retailers know. "We're not doing business with Sam's," he informed them without elaborating. "I didn't mind if they wanted to think I had terminated the relationship," he explains. Almost immediately, Home Depot added GTO's gate openers to a dozen more of its stores. In 1997 business with the Home Depot account rose 134% over what it had been in 1996, representing $811,000 in revenues. Last year sales to Home Depot were up 146%, rising to $1.9 million. GTO posted sales of about $6.5 million in 1998, netting in the neighborhood of $1.5 million-- excluding the settlement it would ultimately receive from Wal-Mart.

GTO had filed suit on November 14, 1996, in the Circuit Court of Leon County, Fla. The claim would later allege damages of almost $515,000. With an accountant's help, GTO had calculated that close to $106,000 in unauthorized credits had been taken, for reasons other than returns, by Sam's Club between 1990 and 1996. During the same period, by GTO's reckoning, Sam's Club had wrongly taken discounts of about $100,000. The rest of the claim was attributable to returns of gate openers that were not defective.

The amount of potential liability zoomed higher, in Mitchell's mind, when Coppins revised the suit to add fraud charges, theoretically opening the way to punitive damages. The lawyer had dug up an internal Sam's Club document, a vendor-payback approval form, that had authorized Bevis to pay $35,986.89 to GTO. On the form he had written: "Vendor has received abused, nondefective, inappropriate returns and unauthorized returns. Vendor is willing to absorb $81,829 of $117,816." As Coppins argued, it was "like Bevis saying, 'GTO caught us, but we can squeak by with $35,000." Wal-Mart's attorney Gill, on the other hand, claims that Bevis had merely copied down what GTO had told him. By having that check cut, Coppins says, Bevis was agreeing to do business with GTO under the new terms--something he didn't have either the authority, or the intention, to carry out.

The trial was scheduled for August 31. "I wanted those punitive damages," says Mitchell. "If we were going to trial, I wanted to go for the throat."

Gill admits that "the judge in this case indicated that he would be likely to let it go to the jury." But he contends that any such damages "wouldn't be upheld on appeal." He adds, "They made the outrageous claim that we were making money on these returns. We were going to be able to show that it cost us more to handle the returns. It wasn't a moneymaker."

On August 18, Gill received a letter from Coppins detailing the exhibits GTO had prepared for the trial. Those documents, Gill says, "led me to believe that he was going to be able to prove somewhere in the neighborhood of that $515,000 in damages"--not including interest, which could have amounted to around $200,000. "There's a lot of gray area in defining what a defective product is," he concedes. "The vendor agreement doesn't define defective." Wal-Mart, he says, was fully prepared to make its own case: that as a customer-focused retailer, it was inclined to believe shoppers who said they had purchased an item that was incomplete or malfunctioning. "It's a reasonable position, as a retailer, that the customer is always right, and if it doesn't meet the customer's satisfaction, it's defective," Gill says. The exception? The diapers, of course, for which Gill acknowledged that Wal-Mart "could offer no definitive explanation."

Then again, Mitchell's own behavior wasn't always simple to explain. Even when Wal-Mart's settlement offer reached $490,000, he held out. "My temper got hold of me," he says. In fact, Mitchell now says he would have accepted $450,000 with one condition: he wanted an apology in writing. "I don't recall him ever asking for an apology," responds Gill.

Mitchell had just arrived home at 7:30 p.m. the night the call came. It was Coppins and an associate. "You got $500,000," they told him. "I wasn't whooping and hollering like I had won the lottery," Mitchell says. "I got five minutes' worth of Wal-Mart's profits. I didn't have any impact on them whatsoever." His wife, Patty, made a toast out on their deck. "There was a sense of anticlimax," recounts Patty, who had glimpsed her husband rehearsing his testimony in the bathroom mirror. "I know he was relieved, and I know he was grateful. But it took a couple of days for him to adjust to the fact that this was how this was going to be resolved."

Some two weeks after the settlement, Mitchell was one of 150 people who celebrated GTO's triumph. Outside the company's offices, in a big school bus, folks were cooking up grouper, shrimp, and mullet. There were hush puppies, biscuits, and iced tea. The chefs, local restaurateurs, were friends of Mitchell's. He had also come up with the idea for the invitation: It showed Sam Walton's capped head on a baby's body, waving his arms in the air and mouthing the words "Wah! Wah! I surrender!" A caption said: "Find out why Sam got chafed by his own Pampers! Hint: There are a half million reasons why."

Joshua Hyatt is a senior editor at Inc.


Risk Factors
When Chuck Mitchell, president of tiny GTO, made up his mind to sue Wal-Mart Stores in 1996 and claim breach of contract, he wasn't merely risking being walloped in court by the world's largest retailer. By taking on his largest customer, he was putting much more on the line, including--

1. Sales growth. In 1996 Sam's Club, the membership-warehouse division of Wal-Mart, represented about 18% of GTO's revenues of $4.5 million. Scrambling to make up for the anticipated $800,000 shortfall, Mitchell had hired additional sales-rep companies in 1995, paying a 6% commission to get the company's automatic gate opener into more retail outlets. After what he describes as "a dicey six months," GTO had added enough business to compensate for a Sam's Club defection, should it occur. Not that anybody--even his banker--fretted about the company's survival. "Wal-Mart may have represented a sizable portion of GTO's sales. It didn't represent a sizable portion of profits," notes Tom Barron, president of Capital City Bank in Tallahassee, Fla. "And bank loans don't get repaid with sales."

2. Employee productivity. "Gosh, I don't want to go to court," controller Marie Payne told her colleagues. "I don't like the idea of sitting up there and being badgered." She wasn't the only GTO employee who felt that way, as Mitchell well knew. "I was worried about some of my people being on the stand," he says. "To sit up there and get grilled by a Wal-Mart attorney who accuses them of being an idiot or a liar, that's not what they get paid to do." Just preparing for the trial took up significant chunks of time. Payne gave up her four-day workweeks to help gather documentation. Harris Welch, an R&D technician, spent 12-hour stretches in a conference room analyzing data about the product returns from Sam's Club. And GTO's lawyer, Michael F. Coppins, spent about 90 minutes preparing each of the 10 employees who gave depositions.

3. Future prospects. Landing Sam's Club as a customer in 1989 had most certainly helped GTO get in the door to see buyers at chains like Home Depot. So Mitchell fully expected that his decision to take on his biggest customer would have repercussions. But Mitchell found that other retailers, especially anybody who saw Sam's Club as a direct competitor, responded by putting the product in more stores. Home Depot is now GTO's biggest customer, and Mitchell expects to get the gate opener onto the shelves of Sears, Roebuck & Co. this year. "We still have big vendors who push us around," Mitchell says, "but not like Wal-Mart."


Damage Done
GTO sued Wal-Mart for almost $515,000, claiming in documents filed in the lawsuit that the retail giant violated its vendor agreement in the following ways:

1. Invalid product returns: $344,000. Between 1994 and 1996, Sam's Club allegedly returned to GTO 821 gate openers that were not defective, taking credits for the costs of freight and handling and the purchase price. In 1995, Sam's Club refunded GTO about $36,000.

2. Inappropriate cash discounts: $100,850. Between 1990 and 1996, Sam's Club, which was entitled to a 2% discount on invoices it paid within 10 days, allegedly took discounts (as much as $22,000 in a single year) even when it paid as many as 12 days after the time limit.

3. Miscellaneous unauthorized credits: $105,660. Also between 1990 and 1996, Sam's Club allegedly took credits to which it wasn't entitled--including allowances for advertising and promotion and new-store discounts. Other credits, for which the company offered no explanation, totaled almost $32,000.

Last updated: Apr 1, 1999




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