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Paradise Lost

How had it come to this? Reell Precision Manufacturing was supposed to be a different kind of company. For years, it thrived, leading its industry, generating profits, and surviving tough times without a single layoff. But now, losing money, torn by accusations and lawsuits, the company is fighting for its life.
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How had it come to this? It was a question Bob L. Wahlstedt had asked himself again and again over the past three years. Almost four decades had gone by since he and his partners founded Reell Precision Manufacturing, in St. Paul. There had been good times and bad times. But Wahlstedt had never been through anything like this.

Business problems were part of it, but they paled alongside the fragmented relationships. So many people had left the company--so many friends, colleagues whom Wahlstedt had known and worked closely with for 10, 20, 25 years. Some of them had been kids in their 20s when they started. He'd seen them marry, watched their children grow up, celebrated their milestones, and mourned the losses in their lives. Reell had been that kind of company. "We want you to bring your whole self to work," he used to tell employees, meaning not just your hands and your brain but "your deepest sense of yourself--wherever you go for inspiration." That was one of the company's four guiding principles: Seek inspirational wisdom. "I don't care whether you get it through prayer, meditation, or nature," Wahlstedt would say. "I just want you to bring it with you when you come here."

Indeed, Wahlstedt sometimes felt he was part of a grand experiment to see whether such a company was even possible. Toward that end, he and his partners had adopted an unusually democratic approach to management, complete with multiple CEOs, employee ownership, a strong aversion to layoffs, and a commitment to letting decisions be made as low in the organization as possible. For years the system had worked spectacularly well. Reell had received numerous honors and awards for its people-centered culture and had been cited repeatedly in books, magazines, and newspaper articles for the way it managed its affairs.

So how had it come to this? How had Reell wound up with the highest turnover rate and lowest employee morale in its history? How had the internal debate about policy turned so bitter and personal? And how had the three founders ended up in a courtroom defending themselves and Reell against breach-of-contract charges being leveled by a man to whom Wahlstedt felt an enormous debt of gratitude and for whom he wished only the best?

During the 1980s and 1990s, Steve Wikstrom had been Wahlstedt's trusted deputy, a critical part of the leadership team, eventually Reell's co-CEO. "My success, my health, and my well-being during those years I attribute to Steve Wikstrom," Wahlstedt says. It was not anger or betrayal that he felt as he sat there watching Wikstrom on the witness stand in the Ramsey County Courthouse last April, trying desperately--and in vain--to make the case that the company and its founders had broken various promises to him. It was sadness--deep, deep sadness. As Wikstrom concluded his testimony, Bob Carlson, who had been co-CEO with him and now served on Reell's board, looked over and saw tears welling up in Wahlstedt's eyes.

"It's like watching a friend die," Carlson recalls his colleague saying to him.

How had it come to this?

You may have never heard of Reell Precision Manufacturing, but if you've ever sat in front of an Apple (NASDAQ:AAPL), IBM, Toshiba, or Dell notebook computer, you've probably used its products. Reell (pronounced ray-ell) is the world's leading designer and manufacturer of hinges that allow the cover of a laptop to hold steady when you put it up, as well as other motion-control products. The company has been around since 1970, when it was founded by three refugees from 3M (NYSE:MMM) --Wahlstedt, Dale Merrick, and Lee Johnson. Today it occupies a nondescript brick-and-glass building on a back road in the woodsy community of Vadnais Heights, just north of St. Paul. There's a parking lot in front, a pond on the side, and a sign on the main door that says: "Please be advised that Reell bans guns on premises. We apologize for any inconvenience. Thank you."

The company's production area is a hive of activity, filled with the hissing, clanking, clickity-clack of machinery turning out hinges and clutches of various types and sizes. Upstairs is a maze of corridors punctuated by offices, alcoves, and meeting rooms. Wander the hallways and Reell's history unfolds before you. Along one wall are plaques memorializing the many patents awarded to the company's engineers over the years, each inscribed with an engineer's name. Along another wall are individual photos of the "co-workers" (Reell-speak for its 210 employees). Then there's the company's "Direction Statement," posted in various locations around the building. "People are the heart of Reell," it says. "We are committed to provide a secure opportunity to earn a livelihood and pursue personal growth."

At one time, no one would have doubted that statement. But today the commitment feels a little shaky. The recent troubles date back to the disastrous year of 2004, when the bottom suddenly dropped out of Reell's laptop hinge sales. Those sales had fueled the company's growth over the previous decade and in 2003 accounted for almost half of its $28.9 million in revenue. Then its largest customer, Toshiba, switched suppliers, and--nearly overnight--hinge sales dropped more than 40 percent, from $13.2 million in 2003 to $7.6 million in 2004. The company managed to break even, but only by cutting the salaries and benefits of all but the lowest-paid employees.

It was the second time in four years that Reell had been forced to institute a temporary pay cut. The previous one, in 2001, had lasted eight months before the company regained its footing. The board, which had merely expressed concern the first time, now decided that drastic action was needed. Wahlstedt and the two other founders had retired by then, leaving things in the hands of the board, which consisted of three outside directors and former co-CEO Carlson. In June 2005, they voted three to one, with Carlson dissenting, to scrap the shared leadership structure that had been Reell's hallmark for 35 years. Henceforth, there would be just one CEO--Eric Donaldson, a former Kodak executive who had joined the company barely six months before. As for Wikstrom, he was given the choice of remaining as president, reporting to the new CEO, or leaving with a severance package of $200,000 plus benefits. Instead, he decided to sue, charging breach of promises and discrimination on various grounds. (Wikstrom declined to be interviewed for this article.)

Reell hasn't been the same since. Employee turnover has doubled. Some believe that the board bears the responsibility for the ugly turn of events and the ongoing malaise. Others are angry at Donaldson. "Eric brought in top-down management," says Joe Arnold, an engineer who worked at Reell for 23 years before resigning last fall. "Two years ago, I felt like I owned Reell. By the time I left, it was just a job. Eric is smart, but he's not as smart as everyone using their brains. He doesn't know what he's lost."

Donaldson, for his part, argues that certain things have to change--that Reell's very survival depends on it. "We're halfway through a five-year turnaround," he says. "We will only endure by becoming explicit about who's responsible for what. In a small company, you can let people find their own way, but we're not so small anymore. The big issue now is accountability, which we didn't have enough of before."

And then there is Wahlstedt. Though he withdrew from day-to-day operations in 1998, he served as the principal link between senior management and the board, which he chaired, for the next seven years. During that time, his fellow board members grew increasingly worried about Reell's dependence on the laptop hinge business, prone as it was to extreme volatility and intense price competition. "We needed to have a constructive dialogue about this, and I should have forced it to happen," he says. "I deeply regret not being absolutely candid and insistent that we engage these concerns."

And yet Wahlstedt also knows that such failings on his or anybody else's part do not tell the whole story. Reell's troubles, he has come to understand, have roots going back many years. Looking back, he sees things he and his partners did, and things they left undone, whose unintended consequences have only recently become visible. Above all, he cannot keep himself from thinking about a single critical choice the company faced 10 years ago, when Reell was less than half its present size.

At the time, laptop manufacturing was moving to Asia. The question was, Should Reell start selling aggressively to overseas manufacturers, competing on price with local suppliers? If the company didn't go after the business and instead held the line on its traditionally high margins, there was a danger that business would suffer and people would have to be laid off--a step the company had managed to avoid since its founding. Rather than take that chance, Wahlstedt and his colleagues decided--for the first time in Reell's history--to go for market share.

It was, they all realized, an important decision. What they couldn't foresee was the chain of events it would set in motion--events that would end up destroying the very culture they were trying to preserve.

If there was one factor that trumped all others in Reell's decision-making, it was the employees' welfare. The bias toward people dated back to the company's origins and the experiences that the three founders--Wahlstedt, Merrick, and Johnson--had had at 3M, where they met in the late 1950s. Although they left 3M at different times and for different reasons, none of them much cared for life at a big company. They wanted to create something more meaningful for themselves.

Merrick, the oldest of the three, was the first to leave. A World War II veteran and, like the others, an engineer, he quit 3M in 1960 and started his own manufacturers' rep firm, which Wahlstedt joined in 1963. Among their customers was a manufacturer of something called wrap spring clutches--mechanical devices used to control motion in various types of machinery. Although the customer's clutches were used in capital equipment, such as machine tools, Merrick and Wahlstedt realized that the basic technology could be adapted for copy machines and tried unsuccessfully to persuade their client to go after that market.

Then, in early 1970, they brought in Johnson as a partner--just as the economy was slowing down. With too many people and not enough business, they spent the summer talking about the opportunity in wrap spring clutches for copy machines. By the fall, they had settled on a plan and a name: Reell Precision Manufacturing, or RPM for short. (Reell is a German word meaning "honest, dependable, or having integrity.")

Over the next few years, the partners developed a successful line of products--as well as a highly unusual way of working together. The three men agreed, among other things, that any major decision they made had to be unanimous. In practice, that meant it often took days to reach a decision, simply because of the time required to discuss issues thoroughly and digest one another's opinions. When they still couldn't agree after such deliberation, they would reshape the question and keep talking. Because each of them had veto power, they were all effectively CEOs.

A company run by committee may sound like a disaster in the making, but the arrangement actually worked. The group's decisions usually turned out to be good ones, and the cooperation shown by the founders made a strong impression on employees. "It was the consistency of the example they set," says engineer Joe Arnold. "They listened. They cared. And they didn't make promises lightly. We watched them and tried to be the same way with each other and with our customers." Indeed, many employees also did much of their work in committees.

The founders' strong religious beliefs played a role in all this. Although only one of them--Merrick--was a practicing Christian to begin with, the other two had had spiritual awakenings in the early years of the company, and their common commitment to their religion shaped every aspect of their approach to business. Through discussions of their faith, for example, they came to believe that Reell's primary objective should be to make products only of the highest quality. They also established a formal policy placing family responsibilities above business responsibilities. Indeed, staff members were expected to put their families first and arrange their schedules accordingly. And they were admonished to "do what is 'right' even if it does not seem to be profitable, expedient, or conventional," in the words of the company's direction statement.

In 1975, these ideals were put to their first major test. As the economy went into recession, Reell's only customer, 3M, suddenly announced that it had all the wrap spring clutches it would need for the year. Fortunately, the partners soon reached a deal with Xerox (NYSE:XRX), whose orders cushioned the blow. But with sales down 40 percent from the previous year, the company was clearly overstaffed. After the usual lengthy deliberations, the triad decided not to lay anyone off. Instead, they reduced their own salaries 50 percent and asked their 10 employees to take a 10 percent pay cut, later increased to 20 percent. As tough as the cuts were, they allowed Reell to get through the period without losing anyone.

And so it went for the next 30 years. Through good times and bad, Reell's leaders struggled to base their decisions on what was best for the co-workers, as the work force grew from 10 to more than 200. The co-workers, in turn, took responsibility for the company. Production line employees did their own quality inspections and maintained the highest standards. Engineers often made decisions that could later involve tens, if not hundreds, of thousands of dollars.

In one case, for example, an engineer developed qualms about working on a new product that would be used to display cigarettes. He shared his concerns with the salesman for the product, who felt the engineer was overreacting; the project, after all, could have been worth as much as $1 million to Reell. When they couldn't resolve the matter on their own, they brought in other colleagues, who couldn't reach a consensus, either. They next went to one of the CEOs, who said only, "It will be interesting to see how you will work this out." Finally, the engineer and the salesman agreed to let the three leaders of their business group have the final say. After interviewing both people, the managers decided to reject the contract. Although the engineer said he would do his part if the decision went against him, they felt it was wrong to make him work on a project that he had ethical problems with.

Throughout it all, the partners dispensed generous bonuses and gifts when cash flow permitted while paying themselves modestly--no more than seven times what an entry-level full-time employee earned. At one point, they established a "sick bank," into which employees could donate their unused sick days and then make withdrawals as needed. In addition, the founders set up an employee stock ownership plan, or ESOP, that eventually wound up owning 43 percent of Reell's stock.

Reell's employees responded with unflagging loyalty. The company's turnover rate was minuscule--generally less than 5 percent annually, compared with 20 percent to 25 percent a year for manufacturers of similar size.

Given this tradition and the culture it spawned, it wasn't difficult to predict what Reell's leaders would do when confronted with the big decision that arose in the late 1990s. By then, laptop hinges had emerged as one of the company's major products. Reell had done well selling to U.S. companies like Apple and Compaq, but the market was changing. Asian manufacturers were taking over. If the hinge business was to expand, Reell would have to begin selling directly to manufacturers in Japan, South Korea, Taiwan, and eventually China. Meanwhile, sales of Reell's other major product--the clutches used in midpriced copy machines--were softening as the market became increasingly polarized between low- and high-priced machines. It appeared that if Reell didn't go into Asia, the company might eventually be forced to consider what it had never done before--laying off employees.

But the Asia move would bring risks of its own. For one thing, the company would be competing with low-cost suppliers on their home turf. Although Reell's hinges have been superior, it wasn't clear that the difference was enough to overcome the lower prices their competitors were charging. The company would be pressured to reduce its margins, something it had steadfastly refused to do.

Some were convinced that success was a sure thing and the returns would easily justify the investment of time and capital. Others argued the company would inevitably be drawn into price wars that it couldn't win. The final decision was, of course, up to the board and the triad, which by then consisted of Wahlstedt, Johnson, and Steve Wikstrom, who had joined the company in 1981, risen to become chief of operations, and succeeded Merrick after he retired, in 1990. The leaders brought in a couple of advisers to help sort through the issues--Margaret Lulic, a consultant, and Stan Nyquist, a business school professor, both of whom subsequently joined the board. But in the end, as always, there was only one issue that counted: the possibility of layoffs.

In 1997, Reell's salespeople began making sales calls in Asia--and got nowhere at first. Then Reell came out with a new, patented technology that allowed it to produce high-quality hinges almost 30 percent smaller than those made by its competitors. That was a significant advantage to manufacturers of the sleeker, lighter, thinner laptops that were in growing demand. Sales of the new hinges took off, and margins remained strong.

The move into Asia coincided with another important event: the retirement of the two remaining founders. By then, Wikstrom had been at Reell for 17 years , and some thought he could handle the job alone. Along the way, however, he had become a passionate believer in shared leadership. When a board member suggested he become the sole CEO, he demurred. "If I'm offered the job, I will decline," he said. "But if we're talking about a co-CEO, and we find someone whose skills are complementary to mine, I'm very interested."

The person ultimately selected was Carlson--a West Point graduate, Vietnam veteran, ex-IBM sales rep, and Wharton alumnus. He had worked in sales and marketing for several companies before deciding that he had had enough of corporate life, whereupon he started his own consulting business in the Twin Cities. Lulic, who had interviewed him for a book she had written, approached him about the co-CEO job. When he said he wasn't interested, she insisted he read the chapter in her book about Reell. He did and changed his mind, and the triad became a dyad.

For the first couple of years under the new regime, things could hardly have gone better. Sales almost doubled, from $16.9 million in 1998 to $29.6 million in 2000, and the size of the work force topped 200. Driving the growth were the sales of laptop hinges, which skyrocketed from $5.2 million in 1998 to $19 million in 2000, generating operating profit of $2.8 million. Reell's share of the laptop hinge market hit an eye-popping 25 percent.

Wahlstedt, for his part, couldn't have been happier. "I am pleased to say...that the company has never functioned better," he wrote in a company history that he had been putting together over the years. "There is greater synergy between individuals and departments than ever before and many individuals are flourishing in ways that once seemed impossible. Steve Wikstrom and Bob Carlson have proved to be wonderfully compatible and complementary...clearly demonstrating that the shared leadership success of the Founders was not a 'fluke.' "

"Do you play bridge?" Bob Wahlstedt asks. He is sitting in a small alcove adjacent to the office shared by Reell's new CEO, Donaldson, and its president, Kyle Smith, who joined the company in 2006. At 74, Wahlstedt still has a commanding presence, but you can sense the weight of the years--especially the past six years--on his shoulders.

"Have you ever heard of duplicate bridge?" he asks. "It's when different people play the same hand in different games that go on at the same time. Afterward, you see the different ways that the hand could be played." He speaks slowly, stopping occasionally to measure his words. "I'd like to go back and make one or two different decisions, and then see what would have happened. What if we'd decided not to go into Asia? Our non-Asian business is as big in volume and as profitable today as it was in 1998. Maybe we were wrong when we thought we'd have to lay people off." He pauses. "Or what if we'd gone into Asia but priced our products to protect our margins and let the volume fall where it may?" There is a wistful look on his face. Then he gives a little shrug. "But you can't play duplicate life, can you?"

So much has changed since he wrote his last, hopeful entry in the company history. He now knows the long-term consequences of that decision in 1998. He traces the steps. "We made concessions on price to get volume," Wahlstedt says. "Was it right? It was in contrast to our history. We'd always used price to maintain margin. What if we'd done that here? It might have cost us some business, but would we be better off?" To handle the volume, Reell doubled the size of its building and spent some $1 million on new automation. As a result, it went from coping with volume to needing volume, which just increased the pressure to make further concessions on price.

Competing on price led to sales volatility. All a competitor had to do was offer a lower price and--poof--the sales would disappear. The volatility, in turn, helped undermine the plan Wahlstedt and his colleagues had had in mind when they made the Asia decision. "Our strategy was to build a bridge from where we were to where we wanted to go long term," he says. "We didn't want to lay people off, and we wanted to buy time to get to the next level." By that, he means developing new markets and new high-margin products that could sustain Reell well into the future. "But the market didn't let us do it. A combination of the volume, the price pressure, the volatility, and the massive investment resulted in all of our energy going into developing the Asia business instead of finding new opportunities."

So how and why had the company strayed from its historical commitment to maintaining its high margins? Was Reell's culture part of the problem? Did it lead, if not to complacency, then to a certain blindness to the business realities and the initiatives needed to sustain the culture?

Wahlstedt concedes that Reell put too much emphasis on its identity as a great place to work and not enough on paying attention to the financial needs of the business. "Whether or not we'd changed leadership, we would have lost both the value and the financial stability of the business without getting more intentional about those things," he says.

These days, Reell certainly feels like a company that has gotten intentional about those things. Wherever you go, you see graphs, charts, logs, and diagrams. The walls of the production area, in particular, are plastered with scoreboards and Kaizen trees, reflecting the company's relatively recent embrace of lean manufacturing. "These are all little factories," says Donaldson, motioning to the clusters of people at work. He points to one of the charts. "They can track their profitability and their scrap daily. They manage it like a small business."

Although Reell had dabbled for years in programs to improve efficiency, it did not begin to implement lean manufacturing companywide until late 2004, during the last round of pay cuts, when Wikstrom and Carlson were still co-CEOs. Donaldson has continued to support the effort, even taking early-morning shifts on the shop floor. At the moment, in fact, he has just come off working on hinge assembly from 4 a.m. to 7:30 a.m. "It's so important," he says. He motions again to the workers. "These people are the surgeons. We are the nurses."

It feels like a sales pitch, and what Donaldson seems to be selling is himself, which is understandable. After all, he is still trying to win the confidence and trust of Reell's employees, and he does not appear to be having much success. People aren't very receptive to sales pitches when they have gone without raises for four years and when every prediction of better times ahead has gone unfulfilled.

The way Donaldson was introduced to Reell didn't help. It is hard to imagine a messier change of leadership than the one orchestrated by Reell's board in the spring and summer of 2005. "The way we handled the transition was an abomination, a horror; just a massive failure on our part," says Carlson. He and Wikstrom had recruited Donaldson, who joined as vice president of engineering in January 2007. People were just getting to know him when--all at once--Wikstrom, Carlson, and the idea of shared leadership were gone and Donaldson was the sole CEO. Particularly shocking was the sudden and complete disappearance of Wikstrom, who had been with Reell for 24 years, had many friends there, and was closely identified with everything the co-workers valued in its culture. And why had the board ditched the concept of multiple CEOs, anyway?

On the other hand, many of the changes Donaldson has made no doubt were necessary, given the challenges he faced when he started and continues to face. In effect, he and Smith, Reell's president, are trying to take a once-profitable small company and build it into an again-profitable large company, and the systems they have introduced are those that a large company will need. Even so, the obstacles are daunting. Selling laptop hinges is increasingly a commodity business, and Reell still hasn't figured out how to earn a profit from it. For several months in 2007, for example, hinge sales at Reell hit their highest level ever, but the company still lost money. Meanwhile, the engineering staff has experienced significant attrition, including some of the most talented members of the old guard. What's more, Donaldson may need outside capital to complete the transition, and Reell is not well positioned to raise it. Aside from the company's recent financial troubles, the presence of the ESOP--with its 43 percent ownership stake--makes bringing in equity partners extremely complicated.

The three founders, who have agreed to return to the board for a limited time, are well aware of the challenges. Merrick, now 82, says he feels "pretty inadequate relative to the current state of things." Wahlstedt feels the same way. "If I was 20 or 30 years younger and found myself in Eric's position, I just hope I'd have the wisdom to say, 'I don't belong here,' " he says. "What the company needs now is something I'm not good at or even something I want to be good at. I don't like structure. I hated the quarterly reporting at 3M. That's part of the reason we got as big as we did without much structure. But now the company needs it." "We had our season," adds Johnson, 73. "Now Reell needs new skills to take it where it's going."

But along the way, something has been lost, and most old-timers realize that whatever it was is probably not coming back. "You had to be there to understand," says Arnold. "The new people don't know the difference, and the rest of us can't explain it. I finally realized I had to leave. I was getting so worked up at home. I was too angry. It wasn't good for me or my family or the company."

As for Wahlstedt, he continues to wonder about the decisions that he and his colleagues made back in the late 1990s. He's still anguished about his former colleague Wikstrom. They haven't spoken since Wikstrom filed his lawsuit. Last year, the judge dismissed some counts for lack of evidence and ruled in favor of Reell on the others. Nonetheless, Wahlstedt believes that maybe, just maybe, there's a chance that he and Wikstrom will be able to reconcile someday. And he insists he is optimistic about Reell. "This is a tough time, but it's a necessary time," he says, "and I believe we're going to come through it. I think there's going to be a better story down the road."

Bo Burlingham is Inc.'s editor-at-large.

Last updated: Feb 1, 2008

BO BURLINGHAM | Staff Writer

Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business.




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