Medici - Normal Illinois

A Seventy-Six-Year-Old Dude’s Attempt to Salvage his Financial Future A Case Study of the Medici in Normal June 2009

Table of Contents 1. When I was a Seventy-Four-Year-Old Dude 2. Establishing the Medici in Normal 3. Thoughts on Ethical Business Behavior 4. What Went Wrong 5. Plans for the Future

Hans Morsbach [email protected]

1. When I was a Seventy-Four-Year-Old Dude In 2005, I was a 74 year old dude who had devoted most of his life to making money, with mixed results but on the whole respectable success. I had achieved some extraordinary feats that had no apparent chance of success and I had amassed a respectable nest egg in the high eight figures—ample enough to provide a comfortable retirement and become a minor philanthropist. Of course, I also made many blunders and missed countless opportunities to make a lot more money. For most of my life, I have been a small-time entrepreneur, and have run many small businesses. My main operation is the Medici Coffee House on 57th Street in Chicago, a business I acquired in 1962. I bought it for $1700, and since I could not afford a new sign at the time, the name remained. It sold coffee and sandwiches and was located behind a bookstore. Slowly, together with a musician friend, we built up the business gradually and steadily. We added pizza and moved to a larger location and incredibly, it is now a multimillion dollar enterprise. Personal History I emigrated form Germany in 1951, attended Georgetown University and graduated from the American University in Washington D.C. I was an average student and did not receive a stellar education, though I excelled in swimming and chess. Upon graduation, I accepted a management training position in Milwaukee. Soon it became apparent that neither my employer nor I was happy, so I got terminated, went to Chicago and got a job in a manufacturing plant. The employer was kind enough to pay my tuition for graduate school and eventually I received an MBA from the University of Chicago. My job was devoid of challenges and I suggested several ways of doing things better. But rather than being appreciated was regarded as a nuisance who had too many ideas. When, in the Christmas season of 1960, I declined to attend a Christmas party because the only black foreman in the plant was not invited. The switchboard operator conveyed the message all over calling me a “nigger lover”. Soon thereafter the personnel manager called me in his office to fire me. I was about to receive my MBA and had little difficulty finding a better job. Soon thereafter, I ran across a real estate operator looking for somebody to run a plastic molding business. I accepted the offer and was paid a decent salary of $12,000 and proceeded to manage an injection molding plastic plant. It was a great experience. The business was run down and mismanaged. I streamlined the operation, and became familiar with the engineering, marketing and administration. I worked very hard and I thought I did well. We did not make money but broke even in a very competitive

industry. My boss, however, encountered problems in his real estate empire and had a sudden intense need for funds and demanded that I sell an injection molding machine and give him the proceeds. I told him that the machine served as collateral for a bank loan. But apparently that did not matter to my boss.. He sent one of his cronies to demand that I sell the machine immediately and then said that if I thought that I could be so straight, he could get evidence to get me into trouble. Wow! That was a new experience for me. I walked, and he ended up in jail. Running the business was great experience for me and was the foundation for later success. Twice again I tried to establish a career in corporate business, once as a consultant and then as a programmer for a P/R application. I was not happy, so I started another restaurant, the Court House Restaurant near the University of Chicago. I formed a partnership with an experienced restaurant lady, but fired her for craziness and incompetence. Again, I found myself in a desperate situation: under-financed, untrained in running a high class restaurant, and unable to attract a competent chef to the south side of Chicago. I did the best I could and though the landlord had offered the space in anticipation of my demise to another operator, I hung on. As a matter of fact, eventually the Court House Restaurant was voted the third best restaurant in Chicago. My success was based on one dish: Bouef Fondue Bourguignonne, which was easy to do and folks loved it. I am about to introduce it in Normal. I survived again, operating the Court House for thirty years until 1995 when the market changed and the present location became untenable. But in the meantime, my pizza business at the Medici on 57th Street flourished. Making Money in the Market. I focussed much of my attention on speculation. I did well on real estate and the stock market. I also invested in farm land. I had read a report that the grain demand from China would cause US farmland to appreciate. It did, but when I read that some farmers moved to South America grow three soybean crops a year, I got scared and sold my position prematurely. All the while, I speculated successfully on the stock market. I thought that my ability to select stock was very sound. I survived all recessions and did so well that I derived most of my income from the stock market and it did not matter how much money I made in the pizza business. I enjoyed owning the Medici, it has been well regarded in the community. As a matter of fact it became kind of an institution and, more recently, I even got a bit of fame because Barack Obama frequented the place. I was living well and prosperously. I was 74 years old, at an age where many of my peers 

had been retired for more than a decade worrying about their health and watching TV. I had taken out time to get involved in the environment as the chairman of the board of a recycling non-for-profit in Chicago. I also had acquired a farm where I planted trees. When I found that nobody had written a sensible book on woodland management, I wrote one: Common Sense Forestry, which is now the most read

book for small woodland owners. I should have been happy, a well-to-do and respected citizen and author of a highly regarded book. What could be better.? It is here that the latest chapter of my existence started, and what I want to relate to you.

2. Establishing the Medici in Normal My existence in Chicago was enviable. I enjoyed owning the Medici on 57th Street near the University of Chicago. Everybody likes the Medici, the guests, the neighborhood, and the employees. The sales volume was a respectable $3.5 million. I have lunch there everyday with Kirsten Esterley, my general manager. She does an excellent job and although profits are modest, Kirsten is trying to do things better. Owning the Medici is a pleasure as the community and the employees appreciate it. Yet everyone assumes that Hans, being a smart dude with an MBA is making a lot of money at the Medici. But appearances can be deceiving. Surprisingly, the Medici was only marginally profitable, making 1 or 2% per year. I am happy to state that since there has been a cash drain from the Medici in Normal, the Medici in Chicago has responded and become much more profitable.

check it out. He came to Chicago and dined at the 57th Street restaurant. He liked it and has been a Medici fan ever since.

For years I had been lamenting the fact that the Medici, being located next to a school, was not allowed to sell liquor. So I wondered how much more money would I make if my guests could enjoy a beer with their pizza? What about an open bar with lots of college kids watching a ball game and enjoying a beer? If a third of my sales are liquor and if the cost of goods sold is 22%, could I increase my income by almost $1 million? I also had many ideas how to design a restaurant, and how it would be my dream place. I had also started a furniture business on my farm where together with Amish neighbors I produce stunningly beautiful end-grain furniture I could showcase in the new restaurant! I had the money and the know-how to establish and operate a new restaurant. So, I decided to do it. It was inconceivable to me that it would not be very successful. Even if it was not an instant success, there was just no way the new restaurant could affect my comfortable life style! I had $2 million in reserve and was absolutely convinced that opening a new restaurant was a sensible idea and very likely to succeed. I am still convinced as I write this paper, that my reasoning was flawless. Well, I was very wrong.

We hired an architect, Josh Behr, a one-time waiter of the Medici in Chicago. He was not very experienced but he is very creative and though the main layout was my idea, much of the design is his. I forgot who first thought of putting a tree into the restaurant but we all agreed it was a good idea. The beautiful woodwork was made in my shop (Shima Woodcraft) in Wisconsin.

When my son Paul and I came to Normal, we dropped into Mayor Chris Koos’s office and inquired how he felt about a new pizza place coming to Normal. No interest, we were told. There are too many pizza places already. But the Medici is special, I asserted, and the mayor promised to

The next task was to find a suitable location. There was an empty storefront (formerly occupied by Other Ports) ideally located in the center of Normal. The owner, a former ISU professor, Bob Steinman, did not want to sell. He had no specific plans, but he was too young to retire and wanted to get involved in some new business. When I asked him whether he would consider becoming a partner in a restaurant he said yes. Thus Bob Steinman, Paul and I became partners in the Steinbach Corporation, which owns the Medici in Normal. Bob’s father owned a restaurant, so he knew about the business. We liked each other, and joining forces appeared a sensible step.

When Bob found out that the neighboring building was for sale, we agreed that it was a good location for a bakery. The Medici Bakery is doing well in Chicago, and since there is no good bakery in Normal-Bloomington, we felt certain that the Medici Bakery in Normal would be successful. We spared no expense making the Medici beautiful and functional. We used the same restaurant equipment firm (JS Design) whose owner has been a good friend for forty years. We were happy to make a deal with Flemley Dickerson contractors and we thought we had a good crew to construct a beautiful restaurant. While it took more time and more money than anticipated, we were pleased with the result. I am glibly summarizing the building of the Medici in a few paragraphs, but be aware that it involved several years of our time, a huge investment and much planning. It involved weekly conferences with construction contractors, engineers and city administrators. Still, it was a fun project and watching your dream project rising can be a wonderful and excit

ing experience. Sure, we spent more money than anticipated, but that is not unusual and was not perceived a problem at the time. Most importantly, the result was spectacular and we were all proud. Confident of our experience as restaurant operators, we were looking forward to instant success. Surely, our expenditure of $7 million was justifiable considering the stunning beauty of the Medici. When I gave a little speech on opening day, I said, “This is a beautiful restaurant, and if somebody else had done it, I would be jealous”. Of course, since then I often wished that somebody else had done it and was stuck paying for it. We were on top of the world and confident of success. We got a lot of publicity, principally because of the tree, and local citizens appeared curious and excited about the Medici. The Town of Normal had exciting plans for the district (they now call it Uptown). A very sympathetic developer (One

Main) was about to commence construction on several welldesigned residential buildings. A large hotel was being built across the street and the town of Normal had sensible plans to build up the town. A convention center was in the advanced planning state. Our location seemed perfect, in the center of town just a block from the ISU campus. The city was also planning ample parking facilities. Also, being a economic development area, there were to be some subsidies. We had arrived at a point of profound optimism. Whenever I had struggled to complete a project in the past, I always felt certain that once the doors were open, everything would go as planned. In realty, things never go quite that smoothly; it usually takes more time than you expect to become profitable. However, this time we were facing not normal growing pains but were stuck in a disorganized mess incurring substantial ongoing losses while creating ill-will in the market place. A full blown disaster!

3. Thoughts on Ethical Business Behavior

I decided to sneak into my Medici story a chapter on business ethics. It is not an intricate part of what I set out to tell you. Just the same, you may find it interesting, but feel free to skip this chapter if pressed for time. I try to live by high ethical standards. I live within the law (so at times I feel that bad laws can be ignored). I feel that it is a citizen’s duty to pay his/her fair share of taxes. When I started running my own business, I had no idea how many small businesses cheat on taxes because I just did not think about it. But as you compete with others, you find out that your competition, by not paying taxes, has a huge advantage over you. When I find out that a competitor is skimming, I boil with fury, as I know that he makes much more money than I do, with less effort. It is as annoying as when somebody cuts in line ahead of you. SKIMMING Skimming is the use of cash without paying taxes. To illustrate how the system works, take my employee Francisco, who is being paid cash by a competitor. Francisco is a busboy and is being paid about $6 an hour, and incredibly, has worked for me and a competitor down the street for 28 years! He also pays taxes on his tips, which constitutes most of his income. Working for the Medici, he receives after taxes about $5 (payroll deductions of $1 on his pay and about $1 in taxes on gratuities). I never inquired how much cash Francisco receives from my unnamed competitor, so I assume that it is about the same. I do know, that the Medici deducts about 25% of his gross pay for payroll taxes (ss, fit, sit totalling $1.50 per hour). In addition, Francisco has to pay his share of taxes on his $6 gross pay (40 cents) and also has to pay about $1.00 tax on his gratuities. In total there is

$2.90 in taxes, which constitutes 45% of his gross pay. But there are more ways my skimming competitor saves money: He pays cash to Francisco, and that cash comes directly out of the cash register and no sales taxes are deducted. Sales taxes are 10.25%, so there is a savings of another 50 cents per hour. Also, my competitor is not paying overtime which not only saves money but also gives him the luxury to have Francisco take up shifts as needed without adding an overtime premium. The precise savings are difficult to quantify, but I figure savings are about 50% of payroll. How much money has my competitor saved over the 28 years? If his savings are as little as $3/hour, his savings are $120/week and $168,000 over twenty eight years, not counting compound interest. My competitor does not have to be smarter or better nor serve better food to enjoy an income much higher than mine! You may ask, why if this upsets me so much I would not complain to the IRS? There are three reasons, (1) I have been conditioned as a kid never to squeal, (2) I am scared, as I can not trust the IRS not to reveal its source of information. And, (3) I entertain a hope that our system find a way to function better in the future. Consider further that my competitor has other employees who are paid cash. So the savings of paying cash are huge. I was told by a former manager of Chicago’s most illustrious chain of gourmet restaurants that he was told to skim. I doubt whether the owner still skims; he is getting too big and there may be no need to continue skimming. I am convinced, however, that the practice helped him immensely in getting the capital to expand his chain of high-class restaurants. Returning to Francisco, he does not care about all the de

ductions, he only cares how much money he receives to send to his family in Mexico. Ceteris paribus, he should be more willing to work for the competitor, where he may make a bit more money than at the Medici. As a practical matter, Francisco prefers to work for the Medici: We are nicer to him and tips are a little better. CASH INVESTMENT I have another example of the advantage of tax cheaters. I owned another restaurant in Chicago, the Medici on Surf, which I ran for about ten years. When I had problems with management, I sold it to a big time operator of a small but successful restaurant chain. During the selling negotiation, the buyer took me aside and asked whether I would be willing to sell for less if given cash. I was outraged that he would suggest that his illegal money was better than my legal money and informed him that I am a straight player. He called me a “good boy.” The sale was completed, and upon taking possession the new owners told my assistant managers that they were to be paid the “Greek system,” alternate pay periods in cash. The new owners did not have to change anything to make money. If he did all the same things I did, his tax savings from skimming were sufficient to have a successful business and justify the sum he paid to buy the Medici on Surf from me. His tax savings assured a healthy profit. LEGAL FRAUD Of course, small business tax evaders are no different than the prevailing tax paying morale of larger businesses. Politicians are very corruptible and schemes to avoid taxes are often complex. There is a huge industry devoted to find legal ways to avoid paying taxes. Some of the most obscene tax cheating goes on sanctioned by Congress. Here is one example: our government has huge contractual arrangement with contractors helping to fight our war in Iraq. Many of these contracts are non-competitive and on a cost plus basis. One company was the Bachtel Corporation which has close ties with Vice President Dick Chaney. Cheating was so perverse that Congress decided to ask questions. In open testimony, evidence of cheating became so pervasive that lobbyists prevailed on Congress to have a law passed making it illegal to investigate these contracts. In fact, Congress passed a law making cheating the US Government legal!. What considerations were passed on to members of Congress to consider and pass such an outrageous law? How can all these Congressmen sleep well after defrauding taxpayers legally? Why did the taxpayers not revolt? There was no shame other than an editorial in the New York Times. Lobbyists make a lot of money and pass on campaign contributions which ultimately find its way into the pockets of legislators. It is legal corruption. CREATION OF POISONED SECURITIES Of course there are other ways for executives to enrich

themselves. As our current downturn in the economy reveals, our financial industry has engaged in devising fictitious financial contracts on which they made a lot of money. Executives received enormous commissions on trading “poisoned” mortgage packages where the expected profits had not been realized. Many of the highly paid executives are graduates of the most prestigious universities, such as Harvard and the University of Chicago. Of course, they tend to think that they are very smart and deserve all the money they are being paid. The degree of self-delusion is astonishing as long as it provides fat pay checks. As we all know, the trade in “poisoned” undervalued securities had grave consequences for the economy: (1) the financial markets collapsed (2) the highly compensated financial experts kept their unearned income (3) the value of real estate dropped and home-owners had been sold more mortgages than the value of their homes (4) employment declined as housing and other industries came to a standstill (5) the government spent several trillions to shore up the financial industry to give the economy a chance to resurrect itself. (6) In the long run all taxes have to be increased to pay for the bail out (7) there has been a huge shift in wealth and income in the US in favor of the most affluent. The big cheese executives profiteered handsomely at taxpayers’ expense. EXCESSIVE EXECUTIVE COMPENSATION Executives are paid huge sums because they typically determine who sits on their boards of directors that determine their pay, perks, and stock options. Even in money-losing corporations the executives continue to get paid huge sums. Who is to blame? Who is the looser? Executives are paid by the stockholders and nobody takes on the task of helping stockholders to protect their interests. The investment community, the mutual funds, pension funds, and hedge funds should prevail on the boards of directors to protect stockholders’ interest. However, they find it more profitable to get part of the pie rather than to rock the system. It is very distressing and hopefully our society will find a way to deal with the problem. The Scandinavian countries are doing a much better job than we do. When in the big depression in the 1929, it became clear that new legislation is required to make our system work better, the Roosevelt administration responded and made many changes on which our system is based. Now, there is a need for new laws to regulate our system, and hopefully the Obama administration will be able to take appropriate steps. There are some early signs that stockholders are becoming aware that they are being ripped off by management. But it will take a groundswell of public disgust to change the system. THE PONZI SCHEME In comparison to the sophisticated packaged mortgages and the devilishly complex derivatives, the Ponzi scheme 

employed by a Bernard Madoff is quite primitive. His scheme was to promise to pay a high return to folks eager to do well on their investment. He used funds entrusted to him by new investors to pay relatively lucrative dividends to his earlier investors. As long as he continued to attract a lot of new funds to invest, his scheme worked well. It was only after some folks wanted to make withdraws that his fraud was exposed. Strangely, one financial wiz had written a letter to the SEC urging the agency to investigate Madoff. He was not believed.  REWARDS OF CHEATING EXCEED THE RISK The higher the rewards for cheating and the smaller the probability to get caught, the higher the propensity to cheat. The government is doing a lousy job of collecting taxes and many businesses get away with cheating. Some time ago, I decided to make my feelings known and wrote an OpEd piece for the New York Times which was published in April of 1995. It elicited some reaction form readers who agreed with my assertion, but of course, it did not change anything.  Businesses have many ways to make money at tax-payers’ expense. Moving subsidiaries overseas saves a lot. There are numerous ways to gain tax advantages and President Bush had successfully avoided paying millions in taxes owed when he was in business. CAN BUSINESSES BECOME MORE ETHICAL? I would assume that a good business school would instill a sense of responsibility in their students. My son took courses in the University of Chicago School of Business and ethics were never mentioned. Is it different at ISU? Are you being told how much cheating is going on by your professors? Frankly, I would be surprised if business ethics are given much attention. The underlying assumption is that it is more important to learn how to make money than to main-

tain high ethical standards.  Sometimes I wonder how cheating affects the perpetrators. Do they sleep well? I am sure that my unnamed competitor sleeps very well in his million dollar home paid for in cash. Rich people sleep better than poor people; they do not have to worry about money. Also, running a business with a huge competitive advantage provides a nice cushion. I have a harder time making money honestly and running a business in a low profit margin industry can be stressful. On the other hand, I must assume that Mr. Madoff may have had a few sleepless nights. Ripping off $50 billion often from retirement funds should entail some stress. But the folks being caught and persecuted by the government is a small percentage and the folks going to jail is a minute number. The upshot is, it pays to cheat. Our society holds successful businessmen in high esteem, even if they are known cheaters. Consider Joe Kennedy, the father of John Kennedy, who made fortunes manipulating stocks before the depression of 1929. He had figured out how to manipulate stock transaction of make millions. Later, he was nice enough to help the feds to pass legislation to make stock trading more honest. His suggestions were the foundation of the establishment of the SEC. Some cheating profiteers come out smelling like a rose, others become big time philanthropists. On a positive side, the richest men in the world are honest (Warren Buffet and Bill Gates) and so things are not all bad. I apologize for digressing from my announced topic, I just cannot help it and I hope that the students of ISU get a good foundation in ethical behavior. Reading the financial papers constantly reveal exposures of cheating. Tax attorneys tend to be one step ahead of tax enforcement. This is costly to society as the government not only loses tax revenue, but the expenses of the process and the legal defense are all tax deductible.

4. What Went Wrong

My business experience provided me with repeated challenges which I fought hard to survive, and I did. So, I felt confident that I would be successful in Normal. I felt very secure that I could overcome any difficulties. I was wrong, very many things went wrong. What were they? 1. Selecting poor general managers. We were very happy to locate a very bright GM who had been running a chain restaurant for fifteen years and was eager to work at a higher-class restaurant. She knew the local market and assured us that she had enjoyed excellent rapport with her former employees and many were eager to follow her to the Medici. We completely trusted her and initially she seemed capable. Long before we opened, she wrote procedures, bought supplies, made contacts with suppliers, interviewed

employees, and wrote manuals and procedures. Yet, on opening day, there were way too many employees, none of them were properly trained and it was absolute chaos. The food was not good, the service lousy and costs out of sight. We learned that we had not checked out applicants as thoroughly as we thought.

We asked her to leave and hired a professional GM. He was very knowledgeable, he understood costs and immediately proceeded to cut payroll. He hired a new chef. We did not like him all that much but the new GM persuaded us that he was a brilliant administrator which was more important than being a culinary expert. We believed him. We had hired the New GM somewhat precipitously and had not checked out his references. When we did, we could not find 

any derogatory information except that one former employer said “he was bad news”. We asked him about it and he assured us that he had a personal conflict with his former boss and suggested we should not take that information seriously. After about a month, he took a few days off and did not return. We were told that he went out of town and fell sick and was hospitalized. We got suspicious and found out all kinds of things. He was a thief and had warrants out for his arrest in several states. Looking further, we found that he had ripped us off for about $25,000 some of it very primitively by putting part of our daily deposit in his pocket. The McLean County states attorney was not interested in pursuing his case nor was the state which had an outstanding warrant for his arrest. Apparently, It does not pay to bother to pick up a thief, put him on trial and then jail him. It may not be the best way to spend tax-payers’ money. We have not heard from him since and I would not be surprised if he continues to rip of businesses before he gets caught or beat up., The third GM was a very intelligent young assistant manager whom we promoted. I always felt excited about giving young people a chance to do really well. She tried but it just did not work. She walked out after a couple of months unable to take the pressure. The fourth GM was a former employee of mine who had managed the Medici about twenty years ago, turned to horse handicapping for a decade, and was excited about the opportunity to manage a high class place. He moved from Chicago. His wife did not like being alone and he felt running the Medici was more difficult than he had anticipated and quit after a few weeks. After being in business for more than a year we did not have a competent manager. Our fifth GM is a local professional who had approached Bob Steinman for a job. His name is Steffan Block and is our current GM. We like him and he is doing a god job. The conclusion? Initially, we were not vigilant in assessing the performance of our first hire. We were too invested in our initial selection. As owners, finding a replacement GM is an involved process and there may be a tendency to retain poor managers to avoid the arduous process of finding a new one. Once she failed, we were making fast decisions often based on imperfect information. We had to fill the job and there was no time for a lengthy recruiting and vetting process. It took us a year to hit pay-dirt. Finding a competent manager is always difficult, even when not rushed to make a fast decision.   2. Economic downturn. The recession affected the Medici in several ways. First I lost most of my stock investment. I had made money in the stock-market for years and felt so confident that I operated on margin. I had successfully survived past recessions and felt confident that my brilliant stock selection would make it unlikely that I would lose money. Well, I was wrong. I lost most of my stock portfolio,

and when I finally realized I was wrong, I had lost more than a million dollars. This was my reserve money available to invest in the Medici in Normal if things became bad. The downturn affected us in other ways as well. Business activity in general is down and the restaurant industry in particular is hard hit. Further, a major real estate developer cancelled plans for condo construction in Normal. We were hoping that hundreds of expensive condos would come on the market whose residents would become good customers. Conclusion? In hindsight, it appears that we should have thought of the possibility that the economy could turn sour. Conceptually, a good manager could assign probability factors to developments such as a recession. If I had known that there is a 10% chance of a recession, I doubt whether it would have changed my decision making. 3. Infrastructure changes in Uptown. We found out recently that the Town of Normal is planning to redo the water supply and sewage connection on North Street involving a need to close down the street for five months. During construction, the Medici is invisible from cars and access for guests is limited to a four foot wide side walk. We knew some sewage work was planned, but we did not know whether the work would be in the alley or on North Avenue and we did not dream that it could take five months to complete. Conclusion? Again, an element of arrogance creeps in. We thought that we are so good that any changes in the infrastructure would not matter. 4. Poor selection of chefs. It is difficult to hire a good chef. It is hard to find one, hard to assess his capabilities and difficult to find individuals who have good culinary skills and are good kitchen managers as well. As I write this, I am embarrassed to admit that I have been unable to find a reasonable chef for a year. We hired and fired six chefs in rather fast succession. Fortunately we have a sous-chef who has been loyal to the Medici and is doing his best. But the job is too much for him. It takes two chefs, a sous-chef and a chief chef and we have not found one. We are looking now. Having a weak kitchen has been a problem. Beyond chefs there are cooks and we have had problems on that score as well. Further, we had one rather skilled cook who ripped off surprisingly large quantities of food. So our kitchen operation has been quite problematic and the quality of food inconsistent. A high turnover of cooks made a bad situation worse. Conclusion? It is hard to find a top-notch chef. We always felt we hired the most qualified from the applicant pool. When we found our final choice, Josh Huddleton, there was no doubt in our minds that we had found a winner. It just takes time to find a top performer. It takes perseverance and we displayed it. It is interesting to follow what happened to managers and chefs we let go. If they embarked on a successful careers and got jobs at higher rates of pay, it would indicate that we had 

made a bad choice. None of our discarded employees has been offered and retained a better jobs. We did right by firing them yet made poor initial hiring choices. A more charitable way of looking at our experience is to conclude that good chefs (and GMs) rarely look for work. 5. Poor Service. Most of our applicants for servers had no prior experience,. We had to train them. Now we train them for four shifts before the can handle customers on their own. But when we started out training was bad resulting in poor service. We are very happy with the quality of applicants who tend to be sensible ISU students. It was our fault that we did not provide sufficient training. Conclusion? I do not think that we did anything basically wrong and the quality of our service has been improving gradually. Our assistants, who do the training, could have done a better job, but they too were new to the business. I think we are doing fine now, in particular with the new GM. 6. Getting a tarnished reputation. Our food is prepared fresh from high quality ingredients. But we had kitchen problems, together with a high turn-over of kitchen help. This resulted in inconsistency and often slow service. Although almost all guests like the beauty of the restaurant, our service and food was not consistent and some guests did not return. Now we are doing a bit better and we feel that most of our guests receive good food and service, but in the interim, we lost business. It takes some time for disappointed customers to give a restaurant a second chance. Conclusion? When engaging poor management, it is not surprising that the customer satisfaction is poor. Frankly, I am surprised that we have so many returning customers which may be a sign that they like something other than the best food. I think we are overcoming this problem, so it will take time until we will enjoy a stellar reputation. 7. Failure to attract University students to patronize the bar. There are several bars in the area which do a lot of business with ISU students. The Medici is not one of them. We might be too expensive or we may appear too expensive. For whatever reason we do not get much action of the drinking crowd. We have a little action on Wednesday evenings when a group calling themselves the “Midnight Warriors” meet and drink at discounted beer prices. But in general our bar business is very disappointing. We had assumed being so close to the ISU campus, we would have a better following. Now, the kids are walking by the Medici to Pub II or elsewhere. There is a dribbling of students taking a date to the Medici for special occasions but it is much less than we had anticipated. Conclusion? I don’t know what to say. It is just a difficult proposition to attract a new group of clientele. We intend to become more inventive and generous in offering free bar food. We will keep on trying. Our new bar manager may

help, but it is a tough proposition. 8. The community does not know about the Medici. We have spent very little money to advertise the Medici. In Chicago we do not advertise at all, because we are so well known that there is no point in spending money for advertising. We are generous in giving free pizzas for good causes and we invite kindergarten kids to make their own pizzas at the Medici. It is my instinct that I do not want to advertise until our food and service reaches an acceptable degree of perfection. We are not there yet, although we are getting better. Conclusion? We have not been doing much advertising and have low recognition in the community. Frankly, I did not want to do much advertising as long as we felt that our food is not as good as it should be. The best advert sing is great food and service, and I hope to provide it to our market. 9. Our bakery is not doing well. We felt certain that the bakery would be a smashing success because we are convinced that we have the best bread and croissants in town. There is no other bakery in the area providing the same high quality of products as the Medici. The mayor was very excited about having a bakery in Normal. But he is just a single dude not eating much bread. I thought that supermarkets would be happy to sell our bread. This is not the case. Our bread is fresh and supermarket bread is baked off-premise and contain preservatives to make it last longer. This is what customers expect and this is what they get. In Chicago, in contrast, there are a lot of good bakeries and a more sophisticated public is expecting good bread. So we totally struck out on selling bread wholesale. In Chicago, we are on a busy street where thousands of students and staff walk by the Medici Bakery. In Normal, we have almost no walk-in traffic and the sales in the bakery are disastrously low. We are close to closing it down as our sales do not justify the expense. Foot traffic has decreased further with the street torn up until August. One reason we keep the bakery open is that we have to make bread and desserts in the bakery for the restaurant. So the bakery which provides about $1,000,000 in sales in Chicago sells $50,000 in Normal. It is a real problem and a huge money looser. In summary, we totally misjudged the opportunities for a bakery in Normal. We think it will get better over time, but it will take a lot to bring it to a break-even point. It will take years to change the bakery into a profitable business. While I am confident that the fortunes of the restaurant will turn around, I have no such confidence that the bakery will as well. Conclusion? As I am writing this, I am happy to state that the Medici Bakery in Chicago sold $5000 last Saturday. We may never reach such a level in Normal, but it will get better. We have to provide the same excellence of product in Normal as we do in Chicago and it may not pay to do that for 

some time. I don’t have any pat schemes, yet I feel confident that our local customers will learn to appreciate our quality. But in general, I freely admit that I totally miscalculated the appeal of a bakery in Normal. I felt so confident that I commissioned a beautiful wrought-iron sign for which we aid $8.000. 10. Conceptual discussion among owners. The Medici in Chicago was intended to be the model for the Medici in Normal. Since we had spent so much money (about $7 million) and since it was so beautiful, it we felt that we should aim at a higher-class restaurant operation which would be more profitable. We raised some prices. But since we were not always able to deliver outstanding food, there was some resistance to higher prices. We never defined what our market is or whether we wanted to be like the Medici in Chicago or different. We faced so many problems serving competent food and providing reasonable service, that any discussion of a vision did not appear relevant. What does it matter if our line cook has a hard time cooking a hamburger medium rare? To make matters worse, we had a turnover in kitchen staff which hurt consistency. Further we have not been able to develop signature dishes which are designed to produce reliable favorites which brings customers back to enjoy their chosen dishes. Currently, the partners engage in testy discussion on whether the patio should have a separate menu. Being the senior stockholder, I am putting down my foot on that one. There will be a separate menu, we will be selling fondue and it will be fabulous. Utilizing our upstairs kitchen will make service fast and efficient. Conclusion? Discussions about concept and mission tend to deteriorate into a lot of hot air. The bottom line is consistent high quality food and service. No matter what market we address, the bottom line is the quality of our offerings. Summary The sum of all these problems prevented the Medici to be as successful as we had anticipated. Still, there are many people who like our offerings. Our hamburger and pizzas in particular are always well prepared and price competitive. But we did not achieve the level of perfection to compete in a competitive market. Do I fault my decision making? Surprisingly not much. When I hired chefs, I chose the best available. In general I felt that I made the best decision suggested by controllable variables. I tried to be rational. When making menu changes, I felt that the menu selections agreed upon were reasonable. In dealing with employees, I pushed them as much as I could. Some should have been fired sooner, but that made

little difference. I made many small decisions, for example I had to decide whether to make chocolate croissants. They sell well in Chicago but not in Normal. If I do not make them in Normal we cannot introduce them in that market. If I do make them, we have to incur costs for something which may be tossed out at the end of the day. It is judgment call of no major consequence although many such decisions may add up and thus may make a difference at the end. Sometimes, I don’t know what is the right decision. Another big decision I made was to make the place extraordinarily beautiful which added to the cost. But analyzing the additional cost we concluded that the incremental design expenditure was not more than about 15%. Are guests willing to pay more if they like the space? I presume a little more but, of course, I know of no study determining whether it pays to own a better designed restaurant. However, the place is bigger than it needed to be and since the restaurant is under utilized, so we may have been better off with a smaller restaurant. No matter how irrational it may appear now, I do not regret either decision. I do regret, however, having opened a bakery which added at least half a million to the total cost, an unfortunate sum considering that I lose probably $10,000 a month in the bakery. I guess the main fault was to open a restaurant in Normal in the first place. But I did and it did appear reasonable given the situation at the time. My wife, Kathy, did not want me to do it and my brother Paul thought I was crazy to take the risk because there was no rationale to enter on a new venture. Now my wife fears to become a poor widow. I do not think she will. Bob, Paul, and I are convinced that we will succeed. We may not make as much money as fast as we had hoped and we there were periods when things looked bad and we all lost sleep, but given events which can be anticipated with some certainty, the trend is good. If we were a corporation seeking investors, I would be tempted to buy shares. Let me know if you are interested. I have to warn you, on a recent balance sheet I put down a fat 0 (this means that the aggregate market value of my investment less bank loans is worth nothing) on my assessment of the value of my investment in Normal. It is a very conservative evaluation but some may consider it high. The total investment as it stands now is $7 million and our local banker is getting cold feet. The banker is blaming pressure from his board of directors and from various auditors. Fortunately, I still have enough resources that I can meet all obligations (real and contingent) although I sense that without my reserves, our lenders would blow the whistle. Selling out now would be a disaster for us and a great opportunity for somebody smarter to enter the business cheaply. That is not going to happen.



5. Plans for the Future

The losses incurred by the Medici in Normal have been sizable and given the wealth of stockholders, unsustainable. It is easy to lose a lot of money fast in an unprofitable restaurant and as the principle owner, I had to generate cash to sustain the operation. It is very important to pay bills on time in particular as new restaurants are known to have a high failure rate. It we fall behind in meeting our obligations, suppliers will no longer give us credit. Typically they will insist on COD deliveries that would further curtail cash flow. Since I had lost a lot of my money in the stock market, I had to find sources of funds to support the Medici in Normal. I put more effort to make the Chicago Medici profitable. We had increased prices in 2008 and as the commodity prices dropped our cost of goods sold went down. Also, in the University of Chicago neighborhood, the recession did not affect our sales, as the university community is relatively wealthy. As a matter of fact our sales increased. So there was a more positive cash flow from the Medici in Chicago. Further, I decreased my expenditure. I eliminated charitable contributions and reduced personal expenditures. My next step will be to liquidate assets. My investment in Normal is relatively massive and giving up on the venture is not an option. I did personally guarantee sizable bank loans and abandoning the Medici in Normal would have disastrous consequences. In addition, my conviction that the Medici in Normal will become a thriving business remains unabated. My wife has expressed fears that she will become a destitute widow. She has been entertaining hopes that we would at some time have the money, time and leisure to travel. Instead she knows that I am fighting to establish the Medici in Normal and she is afraid that if something happens to me that she will have a big problem on her hands. I keep telling her not to worry. Our plans to improve the operation are: (1) As the new GM has the opportunity to complete his planned improvements, our food and service will get better (2) we have improved the quality of servers by replacing weak servers with a better trained staff (3) we have hired a new chef which should greatly increase the quality of our dishes (4) the patio is about to open increasing our popularity (5) our banquet activity is on an upswing and we have booked a fair amount of events which tend to be the more profitable sector of our business (5) we hope to attract more bar business by promoting beers and wine sales (6) with the opening of the convention center we hope to attract events to the restaurant, such as banquets and catering (7) we will attempt to make our presence better known by distributing literature to residences in our area. Many locals do not know that the Medici exists (8) we plan to develop pick-up, catering, and delivery business (9) we will continue to cut costs by running an efficient operation. (10) We will continue to inform folks that the Medici Bakery has the best and healthiest bread in the area, and (11) we are negotiating with the SBA for a more

favorable loan. Though our first year of operation has been disastrous, we are confident that we can improve the Medici to become not only the most beautiful restaurant in the area, but also offer the best food and service. We are committed to excel and we are convinced that we will become the most outstanding restaurant in the Normal-Bloomington area. We now feel that with improved staff we are on the way to profitability. We are hopeful that probable foreseeable developments point to success. We have reason to be optimistic. I hope that my Medici experience served to demonstrate that even the best plans could fail. It pays to have good plan and also plan for contingencies if things go wrong. There are many variables at play and it is the skill of a good manager to make sensible decisions at any point in time. Good management is an art, it is hard work, it takes lots of cooperation from employees and management, and it takes vigilance and patience. Yet, events demonstrate that even sensible plans can fail in a big way. If I had made a presentation five years ago on my plan, would you have thought that I was taking a huge gamble? I think that my confidence would have convinced you that Hans obviously knows what he is doing and there was no reason to think otherwise. Well, in the long run, that will be true. Finally, if you have not been at the Medici, please come and check us out. One area where we totally struck out is to attract more student business. The ownership would entertain a proposal to help us develop that part of the business. I hope listening to the story of my near failure will illuminate the risks of stating a business, no matter how well planned. Writing this report was interesting for me as well because it caused me to reflect on the problems we faced. Running a business often does not give you leisure to step back to see and then reflect on the overall picture. My taking the time writing this is a sign that there is light at the end of the tunnel. In reflecting the development of the Medici in Normal investment, it strikes me as strange now that it took a long time before I realized the seriousness of the situation. While my more conservative son Paul has been screaming for a long time that we are going under, I was working on the Stroganoff recipe to make it a signature dish (it is). Paul could not understand that I did not show more concern over our very high payroll costs. Gradually, it became clear to all of us that we had turned the corner. A big step was to find a competent and committed GM (Steffan Block) and more recently the addition of chef (Josh Huddleton), to our staff. We all feel that all the ingredients for success are in place. We will lose money for a few months, but then the sailing should be clear. We will become the best restaurant in the state!