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Ducati: Taking on the Challenge

On the first business day of January 2006, Federico Minoli pulled up and parked his Ducati Multistrada motorcycle in front of the Ducati headquarters in Bologna, Italy. As he looked up at the complex, which housed offices, the assembly factory and the Ducati museum, he reflected back on the company’s history. 2006 would mark several anniversaries: 80 years since Ducati was established to produce electronic radio equipment; 60 years since Ducati had been producing motorcycles; and ten years since Minoli had become the company’s CEO. Minoli joined the then near bankrupt Ducati in 1996, and led its turnaround by creating the “World of Ducati,” a world that involved superior engineering, Italian heritage, slick design and an undeniable attraction for racing enthusiasts to “join the tribe” and become “Ducatisti.” Revenues moved from €95 million to €380 million from 1996 to 2000. EBITDA improved from a loss to €60 million in the same period. However, in the five subsequent years, business results stalled: revenues fell 2.3 percent on a compound annual growth rate from 2000 to 2005, and EBITDA fell to -€273,000 at the close of 2005.

In late 2005, an agreement was signed by shareholder Texas Pacific Group to sell its 30 percent stake in Ducati to InvestIndustrial Holdings SA and a syndicate of other investors, with the understanding that Ducati would pursue a capital increase of €80 million. Minoli was certain that the new shareholders would demand certain changes to cut costs and get the company’s growth back on track. In selling the concept of the capital increase to the shareholder base, he would need to articulate a plan that would address the immediate financial concerns as well as longer-term strategic considerations. Minoli stated:

“We had a very successful turnaround from 1996 to 2001. The issue with the turnaround was the question ‘what’s next?’ Unfortunately for us, the ‘next’ already happened and it wasn’t very pretty. There’s a big chunk of time, which goes from 2002 to 2005 when some bad things happened at Ducati. What happened in between? I’m oversimplifying the issue but we faltered on the product side. Internally, we had some issues with the product, and the product is at the core of any company like ours. There were also some external factors – the primary one being the decline of the U.S. dollar, which hit us very hard. We have to take that into account when planning for the future. Our strategy is very much affected by what we can actually do as opposed to what we’d like to do.”

The Global Motorcycle Industry

The global motorcycle market included motorcycles, scooters, mopeds and three-wheelers, and was worth $48.3 billion as of 2004.1 Over the past five years, worldwide revenues of motorcycles had grown at a compound annual growth rate of 2.5 percent, while units had grown at 3.3 percent in the same period. In 2004, 28.2 million two wheel motorized vehicles were sold. High displacement motorcycles (over 400cc) made up only a fraction of the overall worldwide market with annual sales of 1.2 million units. The Ducati relevant market was estimated at 642,000 units and was defined as motorcycles in the sports, sport touring and related categories.2 One industry source predicted that the total number of two wheel motorized vehicles would grow by 4.7 percent year on year, reaching 35.5 million units by 2009; 3 meanwhile the high displacement market and the Ducati relevant market would both grow between two and three percent over the next few years. However, there was no universally accepted method of tracking motorcycle sales, and industry players often disagreed as to the correct statistics. Exhibit 1 shows more information on the global market for motorcycles.

Geographic Consumption Asia-Pacific was the leading region, accounting for 56.1 percent of the global market’s value. The U.S. overtook Europe as second-place region in 2004, holding 17.3 percent of the market – Europe had 16.4 percent and the rest of the world made up the remaining 10.1 percent. Industry observers believed that the 1 “Global Motorcycle Manufacturers,” Datamonitor, 2005, p. 9.

2 See the section “Motorcycle Categories” for a breakdown and description of the types of motorcycles in the Ducati Relevant Market.

3 “Global Motorcycle Manufacturers,” Datamonitor, 2005, p. 18.

rationale for Asia-Pacific’s high consumption of motorcycles relative to other markets was because motorcycles were often the primary source of transportation since they were cheaper to purchase and run than automobiles.4 In contrast, consumers in North America and Western Europe often opted for motorcycles as a secondary recreational vehicle. As a result, it was also more common that North Americans and Western Europeans purchased higher priced and higher powered motorcycles.

In recent years, an emerging segment in “BRIC” countries (Brazil, Russia, India and China) referred to as the “new rich” were looking to consume North American and European luxury goods. For example, in China, Harley-Davidson was about to open its first retail outlet, having been absent from the country since World War II. While the company was actively promoting its motorcycles to the Chinese new rich, it was expected that it would face challenges with government restrictions. For example, over 170 cities had limits or bans on motorcycle use for reasons of safety, congestion and pollution. BMW had entered China in April 2003. In 2005, it sold only 70 motorcycles due to motorcycle restrictions and the gap between legally and illegally imported motorcycles. 5 An official from the China Motorcycle Industry Association stated: “Motorcycle riding fans are still eager to get top machines like Harley-Davidsons, but the government policy seems not motorcycle-friendly at all.”6 See Exhibit 2 for country specific information.

Motorcycle Categories Excluding scooters, mopeds and three-wheelers, motorcycles were often broken down into four main categories based on use: touring, cruisers, sport bikes, and off-road. Touring bikes generally had a comfortable upright seating arrangement and were designed for long distance travel. While the seating of cruisers was similar to touring bikes, cruisers often had larger engine sizes (above 750cc) and emphasized styling and chrome fittings. Sport bikes – also called performance motorcycles – were characterized by forward seating and a lighter frame for higher speeds. Off-road bikes had different tires to facilitate driving through mud and dirt and usually had an upright seating position, thick pads and heavy-duty exposed shocks. While engine configurations and regulations changed by country, engine sizes ranged in four categories from 50cc to over 1,800cc. Ducati considered its relevant market to be the Sport segment over 400cc, which was estimated to have annual volumes of 642,000 units in 2005. This was further divided into: Superbike (256,000 units); Naked (239,000 units), Dual (116,000 units) and Sport Touring (31,000 units).

Riders People rode motorcycles for several reasons. A major group of riders chose a motorcycle as an affordable means of transportation and sought fuel efficiency, comfort, ease-of-use and safety. However, motorcycles often transcended their form simply as an engineered method of transit and represented concepts of coolness, freedom, rebellion and desire. Hollywood movies added glamour and pizzazz to motorcycling, ranging from Marlon Brando’s use of a Triumph in the Wild Ones in the

4 Ibid., p. 8.

5 Ryan Nakashima, “Harley-Davidson Plans China Dealership,” http://www.cbsnews.com/stories/2006/01/19/world/main1223010.shtml Jan. 19, 2006

6 Ibid.

1950s through to Carrie-Anne Moss’s high-speed chase on a Ducati 998 Superbike in Matrix Reloaded. Motorcyclists were characterized from gruff leather-clad groups to athletic high-speed brightly colored sports aficionados. Somewhere in between fell the “weekend riders.” All groups had their corresponding networks of clubs, ranging from the 600,000-member strong H.O.G. (Harley Owners Group) to the D.O.C. (Desmo Owners Club). Many riders belonged to two or more different riding clubs with different bikes for a particular occasion or use. Rider clubs arranged frequent rallies or competitions – notably, the annual pilgrimage to Sturgis, South Dakota attracted over 525,000 motorcycle owners (many of whom were Harley Davidson riders). 7 At the other extreme was the Dakar Rally off-road event, where over 1,400 competitors drove through dramatic desert conditions, commencing in a European city, to Dakar, Senegal. 8 In addition to frequent events and competitions, hundreds of ancillary products such as clothing, magazines and music were available to support each branch of motorcycling. In the 1980s and 1990s, the predominant group of motorcyclists were men; however, women were increasingly purchasing motorcycles. In 1990, women accounted for 2 percent of annual motorcycle registrations. By 2005, it was estimated that 10 percent of riders were women.

Ducati’s History: The First 70 Years in Brief: 1926-1995

“People ask what’s the difference between a Ducati and another racing bike. It’s the same difference as eating homemade pasta in a small Italian village versus eating processed pasta in an Italian chain restaurant somewhere in New York. There’s no comparison.” – Livio Lodi, Ducati Museum Curator

In 1926 in Bologna, Italy, Antonio Cavalieri Ducati and his three sons set up Società Radio Brevetti Ducati as a manufacturer of electrical components for radios. In the following 15 years, the company established offices in London, Paris, New York, Sydney and Caracas. During the war, Ducati’s factories were occupied by German forces and then bombed by American forces. At the end of the war, amidst the ashes, the family focused its attention on engineering new products. Immediately following the end of the Second World War, in 1946, the company launched “il Cucciolo.” The original “il Cucciolo” was a small auxiliary motor that could be attached to a bicycle to provide enhanced speed. Eventually, Ducati began producing “il Cucciolo” along with its own frame. The small-sized motorcycle became an instant hit and spawned the development of the Cruiser 175cc and the 98cc. In 1954, an engineer named Fabio Taglioni (known lovingly as “Dr. T”) joined Ducati and cut through conformity by introducing new models and then participating in the races to show the performance of his designs. Some of his designs broke previous records by surpassing speeds of 162 kilometres per hour. He also implemented the Desmodromic valve distribution system, which he had seen work in a race-winning Mercedes automobile in the mid-1950s. The Desmodromic or “Desmo” system allowed for more revolutions per minute and greater

7 Sturgis Motorcycle Rally, http://www.sturgismotorcyclerally.com/newsletter.html, Accessed March 13, 2006.

8 Dakar Rally Website, http://www.dakar.com/2006/presentation/us/r2_chiffres_clefs_01.html, Accessed March 13, 2006.

power. The Desmo innovation was used in subsequent models (it was still used as of 2006), winning hearts with the 450cc Mark 3D, which hit speeds over 170 kilometers per hour, and the twin cylinder 750 Supersport, which signaled Ducati’s dominance in motorcycle racing in the early 1970s marked by Mike Hailwood’s win in the Isle of Man and Paul Smart’s victory in the 1972 Imola race. The racing success attracted attention from all over and was the subject of a David Cronenberg short movie entitled The Italian Machine. Besides racing, the company had experimented in other sectors, such as submitting a bid to supply police forces in the U.S. with the Ducati Apollo in the 1960s and a luxury scooter called the “Cruiser” from 1964 to 1967.

In the early 1980s, the company was losing money. Its majority shareholder (a state-run enterprise) diverted Ducati’s focus from motorcycles to other mechanical products such as small diesel engines.9 However, the strategy was not successful. In 1983, Ducati was purchased by the Castiglioni brothers under the umbrella of their company, the Cagiva Group. The brothers steered Ducati back to motorcycle racing. A slew of new motorcycle models emerged. In 1993, a Ducati designer Miguel Galluzzi developed the Monster, with the aim of cutting out all non-essential components and creating a fun-to-ride street bike with the sensation of being on the race track. The result was a sports racing bike without any of the front or side fairings. A year later, the company released the 916, a high-performance sports bike emphasizing the latest technology, style and performance. The 916 was awarded the “Motorcycle of the Century” title in 2000 by the leading British magazine MCN. However, despite the success of the Monster and the 916, the Cagiva Group did not have sufficient working capital funding to purchase raw materials – this resulted in late deliveries and production delays.10 By 1996, Ducati was on the brink of bankruptcy. A U.S.-based private equity firm, Texas Pacific Group, bought a controlling interest in Ducati with the belief that the company had a strong niche position in the global motorcycle industry.

The Turnaround Strategy: 1996-2001

“Any decision to change, even if well planned and analyzed, always leads to a new territory that needs to be discovered and charted.”11 – Federico Minoli, Ducati CEO and Chairman

Federico Minoli was hired by Texas Pacific Group as Ducati’s new CEO in 1996. Minoli had a long list of accomplishments, starting in the Italian division of Procter & Gamble in 1974 and later moving between consulting firms (McKinsey and Bain & Co.) and industry (as the CEO of the U.S. division of Italian garment brand Benetton). Upon taking the reins of Ducati, Minoli installed a new top-tier management team. However, instead of trying to put a new strict organizational structure in place, Minoli left the largely unstructured company alone to encourage creativity and teamwork. He believed 9 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 16.

10 Gavetti, Giovanni, “Ducati,” Harvard Business School, March 8, 2002, p. 7.

11 Ibid.

that Ducati had three top-notch attributes: a unique and differentiated product, a group of highly skilled engineers, and a brand with high loyalty. The company had been historically oriented towards speed, performance and innovation and some even described the engineers as fanatic “knee down” purists.12 It was a common sight at lunch hour to see engineers in the factory parking lot debating technical specifications and the customization of their own motorcycles.

Minoli had set two goals: double-digit revenue growth and an EBITDA ratio comparable to Harley-Davidson’s of 20 percent. 13 In the first year, Minoli and his management team faced a major decision of where to focus the company’s efforts. Minoli invested in the Ducati brand. The first major investment was commissioning the building of a Ducati museum. Minoli reflected:

“Our workers were operating in an essentially obsolete plant. Conventional wisdom suggested investing in the floor and upgrading the manufacturing capability of Ducati. Much to the contrary, we decided to build the museum.”

Minoli wanted to send a substantially different signal to the company that an ideological change had taken place. He wanted to communicate that Ducati was more than just a motorcycle – it represented a dream. To reflect this change, Minoli and his management team created the “World of Ducati,” which was a strategy aimed at all aspects of the Ducati experience and reinforcing loyalty with the loyal “Ducatisti.” As Minoli stated: “we were moving from the mechanical to entertainment.” 14 To take advantage of the strong Ducati brand, Minoli purchased a controlling interest in Gio.Ca.Moto, an apparel and accessories company that had been producing products for Ducati. It also formed a joint venture with Dainese to develop and manufacture special riding equipment.

The company boosted research and development from €3.2 million in 1997 to €12.9 million in 2000 to build up new products and the racing division. From 1997 to 2000, the company introduced a number of new models under each family. The time to market for new models was reduced from an average of 36 months to 15 months. In 1997, Ducati introduced a new Sport Touring line targeted at an older crowd (over 70 percent were over 30 years old). The entry into Sport Touring was considered a departure from the purist leanings of the past since Ducati’s typical sport customer was 18 to 30 years old. Additionally, the company sought to expand its offerings within each family of products. For example, it targeted the release of entry-level and high-end models simultaneously. One example was the release of the Monster Dark, targeted at new riders, timed with the launch of the high-end Monster Chromo, positioned towards current Monster owners who wanted to upgrade. Exhibit 5 shows Ducati’s price premiums over time in each of its product families.

12 Ibid., p. 8.

13 Ibid., p. 8.

14 Gavetti, Giovanni, “Ducati,” Harvard Business School, March 8, 2002, p. 8.

The company continued to follow a policy of outsourcing the majority of its production to third parties, the majority of which were located in the Emilia region. The Emilia region was known for its automotive racing tradition, as it was home to Ferrari, Maserati and Lamborghini. In 1996, the company was outsourcing 80 percent of its production. By 2001, this had grown to nearly 90 percent. The company maintained the machining of two key components – crank cases and cylinder heads – and assembled all bikes in its production facility in Bologna.

The company’s turnaround strategy produced positive business results. Revenues climbed from €195.6 million in 1997 to €379.5 million in 2000. EBITDA moved from €33.4 million in 1997 to €60.0 million in 2000. Near the end of the turnaround, Texas Pacific Group reduced its holdings from 72 percent of Ducati to 34.8 percent in an initial public offering on the Milan and New York Stock exchanges.15

The “Next” Era: 2002-2005

After five years of growth, Ducati’s financial performance stagnated. Revenues were €362.4 million in 2001, €366.7 million in 2002, €344.0 million in 2003, €363.4 million in 2004 and €320.8 million in 2005. EBITDA decreased from €78.5 million in 2001 to -€273,000 in 2005. In 2005, the company posted an after-tax loss of €41.5 million in comparison with a loss of €3.5 million in 2004. Exhibit 6 shows the company’s financial statements The worsening of results in 2005 was due to a drop in motorcycle volumes combined with an unfavorable mix. Revenues from motorcycles decreased 13.1 percent. In addition, spare parts, accessories and apparel sales dropped by 3.8 percent. Compounding the issue was the drop in the U.S. dollar against the euro, which cost Ducati an estimated €19.3 million in EBITDA in 2004.

In assessing the period from 2002 to 2005, Minoli stated: “We achieved this great growth in the turnaround period, but we also made many mistakes, which were embedded in that growth.” Minoli believed that three major internal issues had contributed to Ducati’s lackluster results from 2002 to 2005: product discontinuity, trouble with the customer acquisition model and a halving of U.S. volumes due to local mismanagement and disruption. At the same time, Ducati released the Multistrada to strong sales response and experienced increased accessory sales and improvements in production efficiencies

At the heart of product discontinuity was Ducati’s top premium Superbike category. In 2004, the company had replaced the popular 998 with the 999, which received tepid reactions from the Ducatisti. Minoli commented:

15 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 16.

“I may be over-dramatizing, but the 999 was too radical. The bike itself is more comfortable, more technologically advanced and has better performance than the 998. We think, and all the data points to the fact that is it is largely a style or look issue. There was continuity in the performance, but there was a clear discontinuity in the look. And, in hindsight, you may say why would you change the look of something that was so successful? If you go back and look at the 998, people would say that was like a Michelangelo. So, why try and recreate a Michelangelo? Instead, we created a Picasso, which is also beautiful, but in a different way. It came across as too angular, too strange and people did not like it. This is a mistake that we will not repeat.”

Claudio Domencali, head of Ducati’s product development and Ducati Corse racing division, commented:

“A sportsbike is for customers who are more traditional and conservative. For a Ferrari, you would never expect a space-moon futuristic car. These designs are an evolution of an evolution. This is our conclusion and maybe we are wrong. Race bikes evolve themselves without making strange steps. The race bike is about being aerodynamic, functional and having certain flowing lines. The 999 was breaking these rules and was trying to create its own way without looking at the racing track.”

While the superbike category did not produce the intended results, the company experienced sales increases with the 2003 release of the Multistrada. In the first full year of production in 2004, Ducati sold 3,898 units. Originally, Minoli was hesitant about the production of the Multistrada as some believed it was a move away from Ducati’s brand soul since it had an upright seating position and larger windshield than Ducati’s other bikes. Some observers wondered if the Multistrada signaled a future move into building a cruiser. Minoli commented: “the Multistrada is nothing like making a cruiser. A parallel would be Porsche’s Cayenne.16 Mind you, if we were to build a cruiser, that would be like Ferrari building a truck!”

Instead of building a cruiser with the Ducati name, Minoli had made several attempts to purchase Italy’s oldest motorcycle, the heritage cruiser MotoGuzzi. As Minoli said, “I see Guzzi as a lighter European version of Harley.”17 Ducati’s interest in MotoGuzzi stretched back to 1998 when MotoGuzzi was purchased by New York equity group Trident Rowan Group for US$8.2 million.18 For the year ending 1999, MotoGuzzi had sales of US$44.8 million per year and a net loss of US$11.9 million. MotoGuzzi had experienced losses for 12 consecutive years.19 Italian manufacturer Aprilia purchased the brand for $66 million (including accumulated debt) in 2000 to complement its

16 The Porsche Cayenne was a sport utility vehicle (SUV) released by Porsche in 2003. The Cayenne caused some turmoil among Porsche 911 and Carrera enthusiasts, as it was seen to move away from Porsche’s key customers. Some accused Porsche of trying to sell to “soccer moms.” However, as of 2005, half of Porsche’s sales were Cayennes.

17 Tom Roderick, “The Italian job: Ducati’s Minoli remains patriotic on the Aprilia buyout,” Dealernews, February 1, 2005, p. 64.

18 MotoGuzzi Annual Report, 10-K, www.sec.gov, December 31, 1999, p. 7.

19 Ibid., p. 8.

portfolio of racing and off-road bikes and scooters.20 When Aprilia went up for sale in 2004, Ducati and Piaggio engaged in a year long public bid for the company. Ducati had initially offered €40 million for the MotoGuzzi brand and Aprilia off-road motorcycle assets.21 In February 2005, Piaggio emerged as the successful acquirer of Aprilia’s entire business. At the time, Minoli commented to the press: “Guzzi is a great brand but it needs a lot of attention and a lot of investment. Colaninno [the leader of Piaggio] has the intention and the money to do it and if he does it will be good for all the sector. If he decides not to, we’re always ready to take it on.”22

Another challenge was the change in the customer acquisition model. The strategy that Ducati had implemented during the turnaround period called for the Monster Dark, priced at €6,000, to “open a door” to new Ducatistis, with the intention of capturing the customer and encouraging an up grade in three to five years to a more expensive bike. As Minoli stated, “we liked the strategy so much, we opened up two new doors in the superbike with the SS651 and the dual with the 620.” However, the two new entry bikes were met with new threats from the four Japanese competitors. Minoli explained what happened:

“The Japanese unpredictably upped the technological content of the entry bike dramatically in the superbike segment and at the same time they lowered the price. We could not increase our price and we cannot compete on costs with the Japanese. Hence, the cost of the maneuver became unbearable. We just scrapped the SS651 project. In the dual segment, we will also have to reconsider the 620 since it’s dragging the profitability down.”

The third challenge was a major decline in the U.S. business. The company’s sales decreased by 39 percent from an all-time high of 7,619 units in 2000 to 4,618 in 2003. In 2001, Ducati North America’s head office moved from the east coast to the west coast. Minoli commented:

“The move caused major disruption. We lost 100 percent of our employees when we moved the U.S. head office. In the meantime, we changed the IT system and basically we did not invoice for four months. It was a major screwup. However, in 2001 we recruited a new CEO, Michael Lock, from Triumph and after two years of suffering, we have been able to recover the lost volume and in 2006 we’ll get back to previous levels. I predict that in two years, the U.S. will become the biggest market.”

Ducati as of 2006

“In five words: Ducati is a sports bike.” – Claudio Domencali, Head of Product Development and Ducati Corse Racing Team.

20 “Italy Aprilia Moto Guzzi,” Associated Press Newswires April 14, 2000.

21 “Ducati Motor Holding confirms its interest in Aprilia Group,” Press Release, www.ducati.com, September 9, 2004.

22 Andrea Mandala and Jane Barrett, “Ducati goes it alone but CEO keeps eyes open,” Reuters News, January 13, 2005.

Products As of early 2006, Ducati produced motorcycles in the Sport segment across six families: Superbike, Super Sport, Sport Naked, Sport Touring, Multistrada and Sportclassic. Within each family, Ducati offered several variations on engine capacity, design and color schemes. All families shared five common characteristics, which gave all Ducati bikes a consistent look and feel. As Lodi stated: “You strip away the fairing on Japanese bikes and you don’t know what brand it is. You can strip away almost everything from a Ducati and you still know it’s a Ducati.”

First, all bikes used the Desmodromic valve control system, which allowed the engine to “breathe” at high speeds, thereby increasing engine performance. 23 The system allowed Ducati’s two-cylinder bikes to perform as consistently as competitors’ four-cylinder engines

Some individuals felt that the Desmo engine was a “self-imposed dogma” that should be reassessed for other alternatives such as pneumatic and spring engines. Domencali commented:

“There’s a good debate inside the company whether the Desmo is necessary on all bikes. For a high performance engine, the Desmo is quite good. Now, we may argue if it is compulsory on some bikes. However, if we took it off the entry-level bike, people may feel that the bike is on the cheap side from a quality perspective.”

Second, all Ducati engines were built in an L-twin design, which involved the two cylinders of the engine mounted at a 90-degree angle. 24 The L-twin design provided improved aerodynamics and lighter weight.25 Third, Ducati motorcycles had a signature low-hum engine sound.26 Fourth, the Ducati frames were built around the Formula One-inspired tubular trestle. Ducati engineers maintained that the tubular trestle frames gave greater rigidity, handling power, enhanced speed and offered a more compact design architecture.27 Fifth, all Ducati bikes were imbued with Italian styling. Industry observers frequently noted that Ducati was in the very heartland of iconic automotive designers since it was in the Emilia region of Italy. Others noted that the bikes generally had lower seating and a lighter weight making them attractive for female riders.

New Product Development Each new motorcycle, including the development of a corresponding engine, took three years on average and cost €20 million. Ducati invested approximately €26.5 million in research and development in 2005, representing 8.3 percent of revenues. This contrasted with €19.3 million (5.3 percent) in 2004 and €12.9 million (3.7 percent) in 2000. In 2005, the company appointed Domenicali, who had been the managing director of Ducati Corse Racing, to take over the development of all products. 23 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 23.

24 Ibid.

25 Ibid.

26 Ibid.

27 Ibid.

Several individuals inside and outside of the company had wondered whether or not Ducati would expand outside of its sports focus by entering the 500cc plus Cruiser segment, which was enjoying growth in the U.S. Minoli commented:

“What makes Ferrari not build a truck? We’ve made a choice to be a racing bike and a cruiser is the antithesis of that. It’s a bathtub on wheels. The cruiser market is dominated by Harley Davidson. You cannot stretch the brand into a cruiser segment. However, we would like to acquire a brand such as MotoGuzzi, which is a great cruiser. But, MotoGuzzi is not for sale.”

Domenicali balanced the view:

“My personal opinion is that if we were to make a cruiser it would need to be on the sports side of the niche. We can do it with the brand. But, it also depends on how you do it. If you’re thinking of a big, comfortable, luxury cruiser then forget it. It would need to be essential Ducati, which means that it would be fast with good braking ability. That’s what would position the bike. At the same time, I think there is a lot of opportunity for us to continue growing in our conventional market – the sports segment.”

Ducati’s in-house design team was responsible for the design and engineering of all new models and series, and all racing bikes for the Grand Prix and World Superbike Championship. Traditionally, the internal design team had taken care of all aspects of designing completely new models, which were not based on previous bikes. In 2004, Ducati had employed an external designer to start from scratch and generate a rough design on paper for a radically new type of bike. The rough design was then handed to the internal design team who engineered the bike through the prototype stage to preparation for the production line. The first model designed under the new method was the Hypermotard, within the Dual segment, planned for release in 2007. Minoli talked about the role of the external designer:

“The question is: how do you predict what someone is going to want in three years? We restructured the very initial part of design and put it outside the company with an independent designer – his job is to come up with the magic!”

In explaining the notion of “magic,” Minoli paralleled the design of motorcycles to the fashion industry:

“There are two approaches in fashion right now. One is what Zara and H&M are doing, which is to reduce the time to market. This is pure process and they have been very successful. The other way is what I call the Italian way, which is a company like Dolce & Gabbana. I don’t know why but for some reason, they are able to know what people want in the future. How do they do it? It’s a mystery. They have something inside and it’s what I call ‘the magic.’ We need that magic at Ducati.”

The Hypermotard was also an example of Ducati using online surveys and a personal blog that Minoli himself had set up to gain feedback. In the online survey, Ducati received 28,000 responses, many from owners of KTM off-road bikes. On the blog,

Minoli asked directly for feedback on the initial design and style. Minoli stated: “many people blasted me for setting up a blog and asking for direct feedback like that, but my point is that it’s a community and we have to build it together.”

Ducati Corse Racing The company saw its participation in professional motorcycle racing as one of its most important initiatives. The company talked about the importance of racing in its annual report:

“The performance of Ducati motorcycles on international professional racing circuits helps to sustain and increase demand for Ducati’s products. Racing increases the visibility of Ducati motorcycles through media coverage of the races and serves as a practical demonstration of the high-performance characteristics of Ducati motorcycles. Our racing program also supports our research and development function, as many features designed specifically for improving performance on the racetrack are later introduced into production Ducati motorcycles.”28

The company managed its racing teams and the manufacturing of specific motorcycles in competitions under the separate company Ducati Corse SRL (spun off in 2005). Ducati competed actively in the World Superbike Championship, clinching 13 manufacturers’ titles since 1990 and winning more single race victories than all other manufacturers combined. 29 In 2003, the company re-entered the Moto Grand Prix Championship for the first time since the 1970s and finished second-place amongst manufacturers.30

Accessories and Spare Parts Ducati sold approximately €29 million of accessories and spare parts in 2005 to support the existing fleet of 350,000 Ducati motorcycles. In 2004, the company outsourced the logistics and storage of the spare parts business in Europe and the U.S. to reduce costs.

On average, owners that purchased a new Ducati motorcycle spent €1,600 within the first six months and up to €3,000 for the top of the range bikes. The most common accessories that were purchased within the first six months were carbon components, special mudguards, aluminum chain guards and exhaust systems by Termignoni. Lucio Attinà, director of Ducati Community, stated:

“Accessories are twice as profitable as motorcycles on the basis of margin. We are equal to Harley Davidson in terms of the amount of accessories that we sell to Ducatistis. We would like to offer accessories so that Ducatistis increase the customization of their bike to between €1,000 and €3,000 at the time of purchase. Then, we hope that the customization will continue within the first six months with expenditures of another €2,000.”

28 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 33.

29 Ibid., p. 34.

30 Ibid.

Apparel As of 2006 the company collaborated with other well-known apparel brands like Oakley, Dainese and Suomy to produce Ducati-branded suits, jackets, gloves, boots, helmets and other gear.31 Ducati also licensed its logo and name for a wide-range of products including other apparel, umbrellas, video games, toys, model replicas and publishing.32 During the business decline from 2002-2005, Ducati had experienced growth in apparel sales. Attinà pointed to Ducati’s participation in the Moto Grand Prix for widening the appeal:

“For the Superbike championship, a lot of the people that attended were Ducati riders. The difference is that with the Moto Grand Prix, there are a lot of people that are big Ducati fans even though they ride scooters. But, they buy Ducati keychains, T-shirts and leather jackets because they aspire to ride a Ducati.”

Marketing The company had a number of marketing initiatives, all of which were aimed at broadening the appeal of the “World of Ducati.” Ducati did not invest in paid advertising to the general public and only placed ads in select motorcycle publications. Minoli explained the rationale:

“The idea with tribal advertising is that you don’t do major advertising. It comes with the dream and it comes through with the racing. Traditional advertising under this approach is blatantly wrong. We are in 60 countries and we will never have critical mass. A lot of people here will disagree with me, but they also don’t understand the concepts of reach and frequency. If you have an ad with no frequency, it’s wasted money.”

Ducati supported enthusiasts’ clubs and relied upon media coverage, events and racing to support the brand name. There were 27 local Ducati clubs around the world in 1998, while in 2005 they had risen to almost 200, totaling an approximate figure of 50,000 members. Ducati established the D.O.C. (Desmo Owners Club) as an umbrella organization to contact the individual clubs and encourage participation in company-related events. One such event was World Ducati Weekend, first hosted at the company museum in 1998 attracting 10,000 Ducati fans. In 2005, the event attendance had risen to over 50,000.

Ducati’s museum and factory tour was another hallmark of the Ducati experience, where visitors could see Ducati’s complete history. The museum had attracted over 500,000 people since its opening in 1998. Lodi stated: “Some visitors have told me it’s like visiting Willy Wonka and the chocolate factory! You can create Ducati fans by showing them the museum and factory.”

The company also offered formal motorcycle training sessions under the name of Ducati Riding Experience. In 2005, the company trained 1,300 individuals in the formal course. Other events included: the Motogiro d’Italia, a tour of Italy on vintage Ducati bikes; the Centopassi, a race through the Alpine mountains; and the Desmo Challenge, a competition for male and female riders.

31 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 27.

32 Ibid.

Other associations with the Ducati brand included art, design, luxury shows and fashion through participation in museum exhibitions, select brand placement (a Ducati was used in coordination with the launch of Zegna’s new cologne) and feature films (the Ducati Monster Dark was used in the film Catwoman). Famous celebrities including Tom Cruise, Brad Pitt and Lyle Lovett had made their affection for Ducatis publicly known. As Patrizia Cianetti, the head of Marketing and Ducati.com stated: “We don’t actually give the bikes away to celebrities. They choose Ducatis because they like them.”

Ducati.com In addition to Ducati.com, the company had eight country-specific websites (Ducati.fr, Ducati.de, Ducati.es, etc.). All Ducati websites strove to provide complete information on model specifications while also allowing visitors an impression of a virtual tour of Ducati’s world headquarters in Bologna. Since the web’s inception in 2000, the company had sold 3,000 custom bikes that were only available online. The company had 10 million unique visitors in 2005 and a database of 200,000 Ducati riders. Ducati frequently used its database to contact riders through email, forums or Minoli’s personal “Desmoblog” to carry out questionnaires on new product developments and user satisfaction. Each year, the company conducted between three and five surveys, with the last questionnaire about the Hypermotard bike generating a record 28,000 responses. Cianetti talked about the value of Ducati.com:

“The website gives us a great communication and relationship opportunity with the Ducati community. In the future, I’d like to do more with the concept of connecting different networks of people and having microhubs within those. Perhaps something like meetup.com. From an aesthetic point of view, we often look to Italian fashion websites.”

Minoli talked about the opportunities with the Internet:

“We’ve actually been able to measure the influence of the Moto Grand Prix on the Internet. It has increased the dream. We have 10 million unique visitors on our website – that’s a huge dream! We have 350,000 bikes, so we must be able to do something with those people who have the dream.”

Sales and Distribution Ducati’s sales network was divided between 800 multi-franchise distribution points in 61 countries and 151 independent mono-franchise Ducati retail stores in select markets such as London, Vienna, Cape Town, Sydney, Hong Kong, Seattle, Paris, Tokyo and Frankfurt.

On the wholesale distribution side, the company sold its motorcycles through wholly owned subsidiaries in North America, Germany, France, Benelux/Scandinavia, the United Kingdom and Japan. Ducati’s management believed that wholly owned subsidiaries that managed wholesale sales in foreign markets offered several benefits: direct contact with the end consumers; more control over marketing initiatives; and, more flexibility to redirect products throughout various distribution points.

In Italy and other countries, the company sold through a network of independent dealers. Ducati had reduced the number of Ducati dealers from 165 in 1996 to 59 in 2005 in Italy, with the intent of focusing on the strong performers and offering enhanced marketing and merchandising support. Most of the Italian dealers sold only Ducati in a Ducati-store format. Ducati encouraged dealers to invest in and upgrade the look and feel of the dealerships to support the brand experience. The company was in the midst of restructuring the dealer network in France, Germany and the UK by using a similar approach to that taken in Italy.

In the U.S., the company was working to improve the quality of distribution points through a combination of Ducati-dedicated shops in select markets and multi-franchise dealerships offering high-end European brands. The major challenge in the U.S. market was seen to been the minimum required number of motorcycles necessary to make a single-brand outlet profitable. Ducati management predicted that 200 bikes per year would need to be sold per distribution point to make it profitable. The infrastructure costs of setting up the back office of the distribution points in the U.S. was estimated to be $7 million. To share the costs of setting up distribution points, Minoli had proposed that European brands band together to have both a joint back office, which he estimated to cost $10 million if shared by three to five brands, and a multi-franchise distribution point. He stated to the press:

“The reality is that none of the European brands have enough volume in the U.S. to be represented by a network of single-line dealers. My idea is that Europeans should do something together in the U.S. The U.S. is such a fragmented and big market and because the Europeans each have a very small share of that market they should team up and offer The House of European Motorcycles and split the overheads and give to whoever does not want to buy Japanese the choice of all the European brands… Of course, if Ducati had the volume that Harley or Honda has in the U.S., I would not even dream of proposing what I’m proposing.”33

Production Located outside of Bologna, Italy, Ducati’s manufacturing facility consisted of 360,000 square meters and had 1,000 employees. The factory was responsible primarily for engine and motorcycle assembly and the machining of crank cases and cylinder heads. In 2005, the facility produced a total of 35,000 finished bikes. Daily output ranged from 120 to 160 bikes with one shift and approximately 250 working days per year. The production facility followed the Toyota Production System, which had been implemented by Porsche Consulting in 1997. The Toyota production principles called for “lean” manufacturing, including concepts such as kaizen (a method for just-in-time raw materials to eliminate inventories) and statistical quality control.

On average, a motorcycle had 1,400 parts. The majority of parts and components were outsourced to third parties. Eighty percent of the value of outsourced parts 34 was

33 Tom Roderick, “Moderating the negative: Ducati says Italy’s not all doom and gloom,” Dealernews, July 1, 2005, Volume 41; Issue 8, p. 42.

34 80 percent refers to the monetary value of COGS. Later the case states that 75 percent of components came from Italy. 75 percent refers to the number of actual components (1,400 X 75% = 1,050 components).

supplied by Italian manufacturers and the top ten suppliers accounted for 45 percent of the value of all outsourced materials. 35 The company implemented a “platform” approach to 83 assembly groups whereby key suppliers were responsible for a specific section of the motorcycle.36 The “platform” approach had contributed to a reduction in the number of suppliers. Many components could be sourced from multiple suppliers. Ducati aimed to have two suppliers for each component and only relied on one supplier for hi-tech parts.37 Approximately 93 percent of the company’s cost of goods sold were from parts and components and 7 percent was attributed to labor and research and development. Ducati was in the midst of trying to build up suppliers in low cost areas such as the Far East and India. Minoli commented:

“A bike has 1,400 components and there may be 20 parts that you don’t want to change. Right now, 25 percent of the components come from this region, 50 percent come from other parts of Italy and 25 percent from Japan for quality reasons – like electronics for example. However, there is an opportunity for more global sourcing. An extreme example would be comparing a fairing made in Florence, Italy for 82 euros and the same one made in Thailand for 8 euros. However, other parts, may give you a reduction in costs of 20 percent maximum.”

Chasing the Magic into the Future

In preparing for the new investors, several options for a future growth plan had circulated through Ducati’s management. Some had even predicted that the company in its current form would be an attractive takeover target for companies in sectors outside of the motorcycle industry, such as Bombardier or Red Bull However, the immediate concern was inoculating the company to get back on a path of sustainable and profitable growth. Minoli summarized his intentions:

“Ducati grew very fast from when we took over in 1996 to about 2001. On a worldwide basis we went from 11,000 motorcycles per year to 40,000 motorcycles. Whenever you grow this aggressively you definitely stretch the organization, and we have been retuning the company in the past two or three years under difficult conditions. We have one more year of stability; then we are planning to start growing again in an aggressive way… We will remain a niche producer, loyal to the sports enthusiast. We do not want to grow to 100,000 units, that is not our strategy.”38

35 Ducati Annual Report, www.sec.gov, 20-F, December 31, 2004, p. 37.

36 Ibid., p. 36.

37 Ibid.

38 Tom Roderick, “Moderating the negative: Ducati says Italy’s not all doom and gloom,” Dealernews, July 1, 2005, Volume 41; Issue 8, p. 42.

Exhibit 1 Global Motorcycle Industry Information

Global Motorcycle Market Share: % Share, by Value in US$, 2004

Honda 17.8%Yamaha 10.0%Harley-Davidson 9.6%Kawasaki 9.6%Suzuki 7.4%BMW 2.6%Ducati 0.7%Other 42.2%Total 100.0%

Ducati Relevant Market: Market Share % by units

Suzuki 25.0%Honda 19.9%Yamaha 18.6%Kawasaki 14.0%BMW 9.1%Ducati 4.4%Triumph 3.2%Buell 1.5%Aprilia 1.2%KTM 1.3%MV Agusta 0.5%

Source: Ducati Company documents.

2001 2002 2003 2004 2005EUnited States Motorcycle Market Units (milions) 0.850 0.936 0.996 1.026 1.073Value (US$ billions) 6.800 7.600 8.200 8.600 9.100 Europe Motorcycle Market Units (millions) 2.067 1.942 1.900 1.866 1.871 Value (US$ billions) 8.659 8.265 8.199 8.157 8.158 Asia-Pacific Motorcycle Market Units (millions) 15.700 17.400 18.600 20.300 21.600Value (US$ billions) 9.600 10.300 11.000 12.100 12.900 Source: “Motorcycles in the United States”, Datamonitor, December 2005, p. 9 & 10. “Motorcycles in Europe”, Datamonitor, 2005, pp. 9 & 10. “Motorcycles in Asia-Pacific”, Datamonitor, 2005, pp. 9 & 10.

Source: “Global Motorcycle Manufacturers”, Datamonitor, 2005, p. 13.

Note: The above market share refers to the total market value in US$ of motorcycles over 100cc. Thisdoes not refer to units. Ducati’s share is the case writers’ estimate.

Exhibit 2 Information on 'BRIC' Countries

Motorcycle SalesValue in US$ (millions) 2001 204.4 189.5 1,700.0 5,500.0 2,250.7 6,800.0 2002 195.0 209.0 2,100.0 5,900.0 2,097.3 7,600.0 2003 192 231.9 2,500.0 6,100.0 2,090.5 8,200.0 2004 199.5 263.6 2,900.0 6,800.0 1,986.9 8,600.0 2005 (e) 207.9 304.8 3,200.0 7,300.0 1,894.5 9,100.0

Units (thousands) 2001 107.9 95.3 4.300,0 10.300,0 594,0 850,0 2002 98.5 98.1 5.100,0 11.200,0 558,4 936,0 2003 99.9 106.4 5.600,0 11.800,0 525,6 996,0 2004 105.4 117.4 6.500,0 12.600,0 482,6 1.025,9 2005 (e) 109.0 128.8 7.200,0 13.300,0 467,0 1.073,0

Source: CIA World Fact Book, www.cia.gov , Accessed May 12, 2006, by country.Global income per capita Growth taken from: http://www.finfacts,com/biz10/globalworldincomepercapita,htm , Accessed July 15, 2006. HNWI information from "World Wealth Report", Capgemini and Merrill Lynch, 2004, p. 31.Motorcycle information from Datamonitor Reports, by country, Motorcycles, pp, 9 & 10 of each report, December 2005.

in US $ Brazil Russia India China Italy U,S,PeoplePopulation 188,078,227 142,893,540 109,535,1995 1,313,973,713 58,133,509 298,444,215Age structure 0-14 years old 25.8% 14.2% 30.8% 20.8% 13.8% 20.4% 15-64 years old 68.1% 71.3% 64.3% 71.4% 66.5% 67.2% +65 years old 6.1% 14.4% 4.9% 7.7% 19.7% 12.5%Median age 28.2 years 38.4 years 24.9 years 32.7 years 42.2 years 36.5 yearsPopulation growth % 1.04% -0.37% 1.38% 0.59% 0.4% 0.91%

EconomicGDP Growth rate 2.4% 5.9% 7.6% 9.3% 0.1% 3.5%GDP/capita 8,400 10,700 3,400 6,300 29,200 41,800Global income per capita growth rate (03-04) 12.0% 30.7% 14.8% 17.3% 21.1% 9.3%GDP by sector Agriculture 10.0% 5.0% 20.6% 14.4% 2.1% 1.0% Industry 39.4% 35,0% 28.1% 53.1% 28.8% 20.7% Services 50.6% 60,0% 51.4% 32.5% 69.1% 78.3%Distribution of family income: Gini Index* 59.7 40,00 32.5 44,00 36,00 45,00 Number of high net worth individuals (HNWI)** 80,000 84,000 61,000 236,000 not avail. 2,272,000 HNWI growth rate - 1 year 6.0% 5.0% 22.0% 12.0% not avail. 14.0% HNWI as % of total population 0.04% 0.06% 0.01% 0.02% not avail. 0.76%

* The Gini Index measures the inequality of a distribution - 0 is perfect equality (everyone has the same income) and 100 is perfect inequality (one person has all the income).** High net worth individuals (HNWI) are defined by those who hold over US$1 million in financial asset wealth.

Comparisons

Exhibit 5 Ducati's Price Premiums vs. Competitors' Comparable Products

Year Hyper-Sport Super-Sport Sport-Touring Naked Dual 1997 31.0% 8.0% 30.0% 13.3% 2001 31.4% 7.2% 20.4% 13.0% 2006 E 33.9% 8.0% 20.0% 28.4% -11.6%

Exhibit 6 Ducati Motor Holding S.p.A. Financials (€ millions)

Source: Company documents.

1997 1998 1999 2000 2001 2002 2003 2004 2005

Revenues 195,6 240,1 294,5 379,5 362,4 366,7 344,0 363,4 320,8 EBITDA 33,4 46,5 50,8 60,0 78,5 59,2 45,2 36,4 (0,3) EBIT 16,4 27,3 26,4 30,4 25,6 14,7 4,3 (4,5) (33,6) Net income 2,7 (1,2) 8,9 10,5 2,0 (3,0) (5,4) (3,5) (41,5)