Once the leading producer of musical synthesizers, Arp Instruments fell victim to managerial incompetence, infighting, and miscalculation.
Alan R. Pearlman never really understood the world of rock music; for him, it was groupies, drugs, and inarticulate musicians. Pearlman, 57, an engineer who had been weaned on classical piano and had spent five years designing amplifiers for the Apollo and Gemini space programs, found pop musicians inexplicable at best and flabbergasting at worst.
One of his favorite anecdotes says it best: "Back in the '60s, Columbia came out with a record called 'Switched-on Bach,' one of the best-selling records of all time, done by somebody named Walter Carlos. . . . More recently, the same person did the sound track for the movie Tron. Now the name is Wendy Carlos."
Pearlman shakes his head in wonder, a crimped smile betraying the anxiety he feels when he considers the implications of the transformation from Walter to Wendy or when he contemplates the fate of Arp Instruments Inc., which he founded in the late 1960s and which quickly became the premier manufacturer of musical synthesizers, instruments able to produce electronic music.
Arp was once a supplier to the stars, providing instruments for Herbie Hancock, Paul McCartney, Stevie Wonder, and Elton John and for such groups as the Bee Gees, Santana, Kiss, the Who, and Earth Wind & Fire. From its inception, Arp was on the cutting edge of technology, and by the mid-'70s it enjoyed preeminence in the marketplace. It had 40% of the $25 million market -- surpassing R. A. Moog lnc., the company that had created the first practical musical synthesizer. But by 198 1, Pearlman's Lexington, Mass., company was dead, the victim of miscalculation and the worst form of mismanagement: no management at all.
Pearlman is now attempting to recover face, his fortune, and his faith in free enterprise, with Selva Systems lnc., a startup company that will manufacture microcomputer graphics software. As chief executive officer of Selva, he sits in a small office one flight up from a store that sells electronic kits in Wellesley, Mass. -- only about 10 miles from the site of Arp's luxurious 50,000-square-foot plant.
"We still have a roof over our heads, and if this company goes, we'll keep it; if it doesn't, we won't," notes Pearlman, who lost $1 million in paper assets and, for a while, his peace of mind, because of what happened at Arp.
A brilliant engineer, Pearlman cofounded Nexus Research Laboratory lnc., a maker of solid-state analog modules (precision circuits used in amplifiers and test equipment, for example), and nurtured it to a solid $4 million sales status before selling out to Teledyne lnc. in 1967. Aroused by "Switched-On Bach," the first major recording hit to feature a synthesizer, he returned to an earlier interest, electronic music. In 1948, as a student at Worcester Polytechnic Institute, he had written a paper on the subject, saying: "The electronic instrument's value is chiefly as a novelty. With greater attention on the part of the engineer to the needs of the musician, the day may not be too remote when the electronic instrument may take its place. . . as a versatile, powerful, and expressive instrument."
Twenty years later, Pearlman made the leap from theory to reality. "1 went into the basement," he says, "and did some playing around." His tinkering yielded promising sounds and a new company.
With $100,000 of his own money and $100,000 from a small group of investors, Pearlman set up Arp in 1969, and in 1970 the company built and showed its first instrument, the 2000. Creating notes electronically, rather than mechanically, had been achieved experimentally within a few years of the invention of the vacuum tube in 1904, and the ancestor of today's keyboard synthesizer made its debut in 1928. But it was not until 1965, when R. A. Moog was founded in Trumansburg, N.Y., that the first commercial synthesizer was made. By 1969, Moog owned the market.
The Arp 2000, however, enjoyed a distinct advantage. The oscillators used by Moog to produce tones tended to drift, which necessitated frequent retuning and made live performances impractical. "We were better at analog electronics," explains Pearlman, "and knew how to keep the oscillators in tune."
Arp had a promising first product, but it was entering a volatile and risky market in which it had no expertise. "At Nexus, I had dealt, for the most part, with other engineers," Pearlman says wistfully. "We spoke the same language and were basically the same sort of people. The musical-instruments business was alien -- I never understood the people."
The company revolved around, and was essentially shaped by, three individuals: Pearlman, chairman of the board; Lewis G. Pollock, legal counsel and chairman of the executive committee; and David Friend, who was president from 1977 to 1980. Each brought distinctive backgrounds, personalities, and goals to the project. Pearlman was the soft-spoken engineer, a man wed to technology but seduced by business. At Nexus, he had made the daily decisions, a chore he hoped to escape at Arp. "I thought, in starting a new company, that I could get others to do it," he says. "I wanted to do long-range R&D, long-range marketing."
Pollock, who had represented Nexus in its merger with Teledyne and had a management consulting contract with Arp, was known as "the entrepreneur's lawyer" but might better have been dubbed the "entrepreneur/lawyer." Although never an officer of Arp, he spent an inordinate amount of time overseeing the company's fortunes. "I'll bet if you looked at his time log, you'd find that he put in 40 hours a week at Arp," says Joseph Mancuso, the author of 14 books on business, a consultant to more than 340 companies, and a former professor of management who was an Arp director for three years. "If any one person ran Arp, and that's debatable," says one insider, "then Pollock was that person."
Friend was the whiz kid, a talented and ambitious young man with a background in engineering and music but none in business. Discovered by Pollock through an article in the Yale University alumni magazine, he was recruited from graduate school at Princeton; at 21, he was the youngest member of Arp's inner circle. The three men sat on Arp's board, along with two outside directors brought in by Pollock, and made up the executive committee, which ran the company. Created by the board at Pollock's suggestion, the committee -- an unusual form of management for a small business -- was entrusted with its operation.
The egos and goals of the three frequently clashed, and their management skills were open to question -- none had ever run a "glamour" company before. Pearlman, in his ivory tower of long-range planning, was initially blind to the severe shortcomings of his management team.
And there were other problems. From the outset, Arp was undercapitalized. In 1973, the company went public, raising $750,000. "We needed the money," says Pearlman. "There was a critical mass we had to achieve in order to pull ahead." In 1973 and 1974, Arp borrowed a total of $600,000 in the form of convertible debentures. In addition, it had an ongoing line of credit with First National Bank of Boston, primarily to cover inventory and to finance receivables. "It was always a borderline company in terms of cash flow " notes Friend. "It lived from hand to mouth the entire time I was there."
A quickly saturated market, pressure on prices, Japanese competition, changing musical tastes, and the vagaries of the instrument business all added to Arp's woes. "Whether or not a product catches on is largely a matter of how well you can get in the front door to see Stevie Wonder," explains Friend. "You rise or fall with each new product."
Over the years, Arp created enough winners to hold the odds at bay. Its Model 2500 synthesizer proved popular with universities and recording studios, and its 2600, Soloist, and Odyssey delighted performers. The company's all-time bestseller was the Omni, introduced in 1975. One of the first polyphonic instruments, it could serve up horns, vibes, electric piano, and a variety of other sounds, and was known for its silky strings, resonant bass, and punchy brass. About 4,000 units (1980 price, $2,450) were sold.
Annual sales climbed from about $865,000 in 1971 to a peak of $7 million in 1977, with net earnings running a lean $232,000. When it had loss years, Arp managed to snap back.
Robert Moog, the founder and president of R. A. Moog, recalls that Arp had problems with quality control and excessive cost of sales (as high as 20%). "The killer, for me, with Arp was that, two or three years after they began, they had a negative net worth of $400,000," says Moog. "I thought I was a rotten businessman -- I was undercapitalized, and I didn't manage things properly. But the worst we ever had was a negative net worth of $11,000."
Pearlman's company not only managed to perpetuate its precarious balancing act, but it generally made the performance look like an inspired success. "Arp was a movie-star company," notes Mancuso, "and Pearlman had the time of his life -- he was donating Arps to the Metropolitan Museum, his name was in the paper, Diana Ross was dropping by. These three guys loved the glamour of running the company, but they weren't doing it in a businesslike way."
When he joined Arp's board in 1976, Mancuso promptly made several elementary management suggestions. The company had done cost-plus pricing, but when it introduced the Omni, Mancuso suggested seeing what the market would bear. With a price tag $1,000 higher, the instrument sold better. Mancuso also recommended that higher-margin domestic orders be filled more quickly than overseas sales, a move that bolstered the company's cash flow. "Mancuso had a lot of good ideas," concedes Pearlman.
In 1977, income and profit soared -- the company had record sales of $7 million, an amazing recovery from the $33,000, 84-a-share, loss it had suffered in 1974. As a result, Arp management grew more expansive. New Chevrolet Blazers were passed out to members of management, and board meetings were followed, on at least one occasion, by an elaborate dinner party. "Each bottle of wine cost about $60," recalls Mancuso.
But the problems that had plagued Arp remained and, in several cases, grew worse. Disco loomed on the horizon -- ready to replace live performers and their instruments with records -- and the Pearlman, Pollock, and Friend combination became even more problematic. Each man pursued his own vision for the company, aligning himself with others to further his own ideas and interests. Memos show Pearlman increasingly alienated from his own company, Friend jockeying for the presidency, and Pollock insisting that Arp perform as a sane company.
In a July 21, 1976, memo to the directors, Pearlman groused that he was being kept in the dark about a guitar synthesizer that was being developed. "I may be oversensitive," he wrote, suspecting "that Dave Friend and [engineer] Tim Gillette were laying down a smokescreen of concealment for fear that I would prematurely criticize their efforts."
At about the same time, in a memo to Pearlman, Friend said, "I believe Lew [Pollock] is exhibiting the classic Freudian behavior of a parent who sees his child emerging as an independent adult. . . . Lew feels that he is in control of Arp now and views my acquiring the title of president as diluting that control."
And, in a July 13, 1977, memo to the executive committee, Pollock insisted: "The company is a rather mature company, and for it to be considered a growth kind of opportunity for investors, acquisitions, etc., the company must, must, have about a 10% pretax earnings. Waiting for next year is no longer excusable." "It was difficult to tell who was running the company," comments Mancuso. "They were doing what I would call management by turns -- 'Pollock is away a week, I'll run it'; 'Friend is away a week, 1'11 run it.' And Pearlman would run it by default when the two of them were away."
Mancuso saw no solution to the strong ambitions and intransigent positions; none of the men was willing to yield power, either to one another or to a CEO who might have been brought in. At one point, as he watched his own authority evaporate, Pearlman considered waging a proxy battle to regain control but -- advised against it by his own attorney -- resigned himself to the status quo. "I didn't know how to fight," he concedes.
Mancuso recommended selling the company, a suggestion that fell on deaf ears. "They were just making money and having fun and thought 1 was crazy," he explains.
Instead, Arp embarked on the most ambitious and dangerous product-development project it had ever undertaken, one that intensified and underscored the rivalry within the executive committee. After having spent eight years accumulating keyboard expertise, Arp decided to create a guitar synthesizer, the Avatar, reasoning that there were four times as many guitarists as there were keyboard players. Whether those guitarists were willing to pay nearly $3,000 for a synthesizer was a question that was never answered by market research.
The 1977 business plan written by Friend called for a research and development commitment so major that a polyphonic keyboard synthesizer under development -- the next step for Arp -- had to be shelved. As far as Pearlman was concerned, it was like "dropping the bird in the hand and going for the bird in the bush." In a memo to the board, he declared, "This project is the riskiest one we have ever undertaken. . . . There are formidable technical problems of sound analysis, as well as synthesis, and we have an unknown amount of R&D" to produce an acceptable working model.
By that time, though, Pearlman had virtually lost his voice at Arp. At one point, he actually feared the board might dismiss him. "It became a political party -- the guitar party," he explains. "It was blasphemy to question anything about it." Friend, who had been largely responsible for several of the company's major successes, including the Omni, and whose standing at Arp prospered as a result, was the driving force behind the Avatar. "Pearlman was opposed to the Avatar," Friend concedes, "but several of our best sellers had been developed over his objections." Aligning himself with Pollock, Friend obtained approval to proceed. The executive committee voted to fund the project, a move the board supported. "Everybody thought it was going to be the hottest thing since the wheel," notes Friend.
"They decided to go for $4 million in the first year," says Pearlman. "Our R&D budget was almost $500,000, and most of it went into the guitar synthesizer. Not only that, we also started to buy inventory for $4 million a year."
The notion that a $7 million company could sell $4 million worth of an as-yet-untested product struck Pearlman as rather naive. "On the basis of objective reasoning, rather than 'bandwagon emotions,' " he wrote the board, "it seems that we are planning to spend over 25% of our 1977R&D money...to make a product which... is more likely to be a disaster than not.
Friend's contagious enthusiasm carried the day, but Pearlman's premonition proved more accurate. Avatar flopped. Although it extended the synthesizer's virtuosity to guitar players -- putting brass, reed, and percussive instruments, as well as sound effects (wind, rain, explosions) at their fingertips -- it didn't do it well enough. Players had difficulty producing a clean sound and disliked the high price tag. And, once the lackluster sales were documented, the Avatar was marketed as a loser. "What you want to do is create a demand," Mancuso says. "But they were begging people to buy it. If you bought two of them, you got a deal. A guy bought six, they shipped him seven -- that kind of marketing."
Arp sold only $1 million worth of Avatars in the two-year life span of the synthesizer. "In 1979, we had an operating loss of about $700,000 and an inventory writeoff of about $300,000," says Pearlman. "So, essentially, we blew our brains out on that instrument."
In the meantime, Mancuso had been desperately trying to peddle the company. "I was trying like hell to sell it," he says with a laugh. "I thought one day I'd slip a letter under their hands and have them sign it -- 'Ha, ha, we fooled you, it's sold! ' They'd have been a lot better off." Mancuso got as far as an informal offer of $10 per share from Gulf & Western Manufacturing Co., when the stock was trading at about $4 per share. But the board remained intransigent. For his efforts, Mancuso was fired.
The same disunity and political infighting that had spawned Avatar prevented the sale of the company. Pearlman, more and more confident that insolvency awaited, was eager to explore the possibility, but he wasn't able to. The board passed a motion prohibiting any officer from talking to a prospective buyer until the offer had been cleared by Arp's law firm, that is, Pollock. Pearlman found himself reduced to holding an "unofficial" meeting with an interested party at Boston's Logan Airport.
Feelers from CBS Musical Instruments were accorded cool and, according to one insider, occasionally arrogant responses.
But, even then, with its cash reserves depleted and time fast running out before the company went under, Arp was not without options. "We could have cut our losses," sighs Pearlman. "We could have said, 'We'll rent out half the building, we'll go very lean, we'll operate in a survival mode.' The biggest mistake was thinking we could turn it around by playing catch-up."
In 1979, Arp introduced a 16-voice electric piano, a versatile and sexy instrument with lots of appeal. "It was supposed to rescue us," says Pearlman. But a switch on the piano failed -- "It was one of those things that went up too fast because we didn't have the time or money to do it right," he admits. "When you left the unit, say, in the back of a hot car, Mylar insulation in the switch would melt." The pianos began to come back in for repairs nearly as quickly as Arp shipped them out.
"The company's sales plummeted, repair costs went up -- all sorts of things started going wrong at that point," recalls Pearlman. That year, the board asked Friend, who had masterminded and pushed Avatar and become president non grata in the process, to resign.
Pearlman returned as president, and another "bailout" product was developed -- Chroma, a remarkable, microcomputer-operated polyphonic synthesizer, which, in fact, would eventually prove quite profitable for another company (see box). But it was too late for Arp. Suppliers were providing parts on a COD-only basis, First National Bank was making angry noises, and, instead of coming to grips with its destiny, management was trying to keep the show going with sleight of hand. Desperately trying to turn 1980 into a breakeveri year, Pearlman lent Arp $168,000 so it could ship a $1 million backlog in November and December. "In January, we discovered that we had created a $300,000 loss," he recounts with obvious regret.
Eventually, Arp found itself pushed beyond desperation; frantic to stay alive, it began playing games with money. Vicepresident of engineering Philip Dodds, who later helped First National unravel Arp's tangled finances, explains that "we were shipping units to dealers with the promise that, if they didn't sell them, we'd take them back and credit them... for the purpose of inflating receivables. The purpose was to generate enough cash flow to get to the point where the practice wouldn 't be necessary."
When First National -- which Arp owed $1.8 million, including nearly $1 million in receivables financing -- found out, it decided to pull the plug.
The bank took Arp to court. After listening to First National and the company's other creditors, the judge appointed a trustee to oversee Arp's liquidation. On May 13, 1981, the trustee took over and on September 11 presided over the sale of all of the company's tangible and intangible assets.
CBS Musical Instruments acquired Arp's inventory for $300,000, and, for an additional $50,000, picked up the manufacturing rights to Chroma and Arp's electric piano. CBS sold more than $3 million worth of Chromas in its first year.
Stockholders and creditors lost more than $4 million when Arp went under; Pearlman and members of his family lost a total of nearly $500,000 in cash.
David Friend, now chairman of Computer Pictures Corp., a Boston-based computer graphics company, maintains a studied indifference to the Arp affair. "We were in a risky business, and we made one bad move," he explains, referring to Avatar. "On top of that, we had some lousy management that blew away what little we had -- that was the end of the ball game."
Pollock prefers to place Arp's failure in a broader context by citing "companies with larger resources, market conditions, and worldwide competition" as elements that contributed to its demise. When pressed, he concedes that Avatar was the critical factor.
Mancuso has a simpler explanation. "Among the three of them, I couldn't get one full-time chief executive officer," he says. "Alone, they're each worth about 0.4 on a scale of 1 to 10; together, they add up to about a 2."
"There was no reason that Arp should ever have gone out of business," says Mancuso. "It's a sin. It's a tragedy to see a beautiful little company, and 200 jobs, go under because of bad management. . . . All three of them -- honest to God -- they should physically have to go to jail and serve six months for screwing up a beautiful thing like that."