Venture Capital Discovers The Mass Market
Walking through La Guardia Airport that afternoon in December of 1981, Mark Weissman struggled to be optimistic. For months he had been trying to find someone to back a company he had founded two years before, Eljenn International Corp. in Newton, Mass., a suburb of Boston. It was a good company, a growing company, but Weissman desperately needed cash to keep it that way. Neither he nor the man he had dragged along with him to the meeting -- Geoff Gordon, Eljenn's vice-president for sales and marketing -- had been drawing paychecks lately.
The meeting, hastily scheduled a few days before, was with a venture capitalist by the name of Michael G. Berolzheimer. Weissman knew practically nothing about the man. He knew only that, of all the potential backers he had contacted so far, Berolzheimer was one of the few who had agreed to spend much time with him. Indeed, that was his sole ground for optimism as he hurried to the appointment.
Weissman remembers thinking how ironic the meeting was likely to be. There he was, a graduate of Massachusetts Institute of Technology, with a patented product that he and Gordon had until recently marketed out of a small apartment; and there was Berolzheimer, not only a venture capitalist, but a venture capitalist from California, no less. The plan was that Berolzheimer would pick up Weissman and Gordon at La Guardia, and they would talk for an hour or so -- whatever it took to navigate the traffic out to Kennedy International Airport, where Berolzheimer was to catch a plane to California.
The irony in all this was Eljenn's main product. It should have been a computer peripheral, a new gene-splicing method, a fiber-optical miracle -- something dazzling, glamorous, etherally technological. It was not. Eljenn's principal asset, the only thing Weissman had to pique the interest of the Californian, besides his own and Gordon's experience and determination, was a shampoo.
Astonishingly, over the din of the rushhour traffic, the meeting went well. Berolzheimer was keenly interested in Weissman and Gordon, in Eljenn, and in the shampoo. Just as astonishing, he seemed incredibly knowledgeable about retail consumer products. He wanted to know, as venture capitalists usually do, how much of their own time and money Gordon and Weissman had invested in Eljenn. They told him about how Weissman, a former science book editor, had convinced friends and relatives to invest some $30,000 to get the shampoo business off the ground. Gordon was one of the friends, and later he had put his mouth where his money was, leaving a well-paying job in a medical technology company to beef up Eljenn's marketing effort. Weissman himself had put in $30,000 of his own by mortgaging his only real asset, a house on Massachusetts's Martha's Vineyard.
But Berolzheimer quickly zeroed in on the product itself: How were they going to market a shampoo in the face of competition from such behemoths of the health and beauty industry as Procter & Gamble Co. and Johnson & Johnson? They told him that, too. The shampoo, called UltraSwim, wasn't just any old shampoo. It was a new formula, patented, already selling briskly ($500,000 a year at the last accounting) in the United States and Canada. It was designed for swimmers, said Weissman and Gordon; the formula got the chlorine out of their hair -- chlorine that turns blonde hair green, curly hair frizzy, and makes hair of any sort as dry as the Sahara.
Yes but, said Berolzheimer. What was the size of the market? Twenty million Americans swim, year 'round, in chlorinated swimming pools, they told him. With that kind of market, they said, they had only to reach a mere fraction of their potential customers to become a $30-million company in three to five years. And they had other ideas besides, other personal-care products for the swimming market.
There wasn't time to say much more. Berolzheimer caught his plane. Weissman and Gordon went back to Boston. A few weeks later, however, they were in San Diego, at the Beauty and Barber Supply Institute trade show, where they ran into one of Berolzheimer's partners, Bill Lanphear. Berolzheimer had sent him down from San Francisco to see them. He had also asked his sister-in-law, a beautician, about the need for a product like UltraSwim. She reported that there really was a need for it. Lanphear, back from the trade show, reported that he had been greatly impressed by Weissman and Gordon.
So it came to pass that, at the end of February 1982, a little more than two months after the airport meeting, Eljenn received an infusion of $650,000 in venture capital -- half from Berolzheimer's venture capital firm, Early Stages Co., and half from a venture partnership in Boston. In return for this support, Eljenn gave up less than half its equity. And UltraSwim survived.
Michael Berolzheimer is an eccentric in the world of venture capital, a man who refuses to be transfixed by electronic wizardry and biological miracles. Some 90% of all private venture money in the United States is currently channeled toward these new frontiers of high technology -- and understandably so. "Our charter," says veteran venturist Bill Edwards of Menlo Park, Calif., the heart of High-Tech America, "is to create wealth, and technology is where wealth is being created most rapidly."
Berolzheimer would hardly disagree. But the russet-haired venture capitalist, now 44, sees another view through the "window of opportunity" opened by his charter. The landscape, he believes, offers many other ways of creating wealth, especially in the supposedly unglamorous markets for consumer products and services.
Berolzheimer's attitude may be unusual, but over the past couple of years, he has become less alone in the belief that there is money to be made outside of high technology. U.S. Venture Partners of Menlo Park, for example, has been investing about one-third of its capital in consumer products, specialty retailing, and low technology. And Marketing Corporation of America, a market research consulting firm in Westport, Conn. (see INC., June 1983, page 58), raised $65 million last winter for a new partnership, called MarketCorp Venture Associates, Limited Partnership. According to its general partners, much of this money will also go into packaged-goods and consumer services, including specialty retailing. Nevertheless, when it comes to nontechnology investing, Berolzheimer's Early Stages is the partnership that the venture capital community is watching most closely.
Berolzheimer came by his curious interest in retail products in the best possible way -- by developing and marketing one himself. The story begins in the mid-1960s in Stockton, Calif., where his family still owns California Cedar Products Co., one of the world's leading suppliers of the wood used in pencils. After graduation from Harvard (first the college, then the business school), Berolzheimer went back to work for the family business, which was having some difficulties. After building up a 30% share of the world market in pencil slats, California Cedar had recently at tracted some formidable new competitors, including the giant forest-products concern Kimberly Clark Corp. Worse, there was trouble among some of California Cedar's oldest customers, who were thoroughly annoyed by a new policy that required them to buy various grades of the wood, even if they wanted only the best. Kimberly Clark stepped in with offers to fill special orders, and secretly reduced prices. California Cedar countered with the somewhat haughty argument that cedar trees don't grow all the same grade of wood. The argument wasn't popular, and the company lost accounts.
This was a marketing battle, and Michael Berolzheimer, armed with the wisdom of his Harvard marketing professors, rushed eagerly into the battle. Traveling all over the world, he listened attentively to California Cedar customers' complaints. Back home in Stockton, he persuaded the man who had been hired to run the company to rescind the new all-grades-or-no-grades policy and to match every one of Kimberly Clark's low bids with an even lower one. The strategy worked. By 1969, California Cedar had managed to fend off Kimberly Clark, in the process boosting its sales from $3 million to $10 million and its market share to 50%.
Looking back, Berolzheimer views the Kimberly Clark episode as the best preparation he could have had for the next step in his business career. It began with a hint from a truck driver he knew. There was all this scrap wood in the company warehouses, the truck driver said. Some of it was being sold locally, but the truck driver wondered if he couldn't try to sell the rest of it at gas stations and convenience stores in northern California. Berolzheimer and his older brother, Philip, told him to go ahead. The scrap wood vanished quickly.
Then, one day, the truck driver came back to Berolzheimer and showed him a log, made of sawdust and wax, that he had picked up in his travels. Why didn't California Cedar produce one like it? the man asked; there was certainly enough sawdust around.
Thus was born Duraflame, the individually wrapped, long-burning firelog that captured America's hearths and minds.
At first, Berolzheimer had no inkling of how well the new logs would sell. There were no large companies in the business -- only a smattering of small regional producers with combined sales of perhaps $2 million. But after less than a year of selling the crudely packaged firelogs -- 30,000 cases of them -- Berolzheimer spied a wider opportunity.His brother-in-law in Virginia had done market research on the East Coast and reported that supermarket chains would give firelogs space on their shelves. With the help of Harvard marketing professor Theodore Levitt, he developed a strategy for selling a snazzier version of the Duraflame logs through retail stores and supermarkets nationwide.
Duraflame Inc. was set up as a separate company, supplied by California Cedar (which had put up $200,000 to buy production equipment). The strategy was to produce a quality product out of the ideal mixture of sawdust and wax. Instead of going toe-to-toe with regional competitors on the basis of price, Berolzheimer set out to establish Duraflame firelogs in a premium category. He wanted to sell them through retail chains and supermarkets all over the United States. To justify higher prices, he recognized that his logs would have to deliver superior performance -- steady burning for about three hours.The technical quality of the product, moreover, would have to be studiously maintained. But beyond these elements, the Duraflame business plan was simple. Through fancy packaging and advertising, Berolzheimer remembers, "We set out to build a brand, to build a brand, and to build a brand."
By 1972, Duraflame was selling more than $2 million worth of its firelogs a year and had staked out a position of leadership in what was a growing national market. With this success, Berolzheimer expected challenges from big national companies. In preparation, he went out looking for managers who were as tough and enterprising as he was. Back at Harvard, he found Bill Lanphear, an MBA with a strong interest in sales and operations.
The next few years proved anything but easy. To begin with, there was the 1974-75 recession, which sapped revenues and profits. Duraflame took its lumps and learned from its lessons, and when the recovery arrived, the firelog industry heated up again. So much so, in fact, that within months, Duraflame was grossing $15 million a year and had 50% of the market. That was too much for Colgate-Palmolive Co., which decided the time was right to move in.
During 1976-77, Duraflame struggled to match its well-heeled rival on prices. Meantime, it stressed the performance features of its firelogs -- what Berolzheimer calls "the quality of the flame." He remembers how Colgate-Palmolive tried with little success to extend the burning time on its product to equal Duraflame's, then raised its prices. It was all over after that. Within a few months, Colgate-Palmolive abandoned the firelog market.
For Berolzheimer, the victory, like the recession, was an important part of his education. "We demonstrated that success in the business wasn't just packaging or advertising or sales," he says. "Despite appearances, ours was a highly technical business. The logs had to perform with consistency, because people compared them with other available products."
By 1978, Duraflame was a $28-million business, and Berolzheimer had achieved what he had set out to do. He had created the best-selling brand name in firelogs, and he was becoming increasingly restless. He had already come up with some new consumer products he was interested in launching through Duraflame, but he was finding it difficult to get the members of his family to commit the necessary resources. After some soul-searching, he began to look for a buyer for Duraflame. In July of 1978, Duraflame was sold to Clorox Co. for some $9 million.
So what was Berolzheimer to do next? He wasn't at all clear about that, but he had enjoyed the excitement of building a new business, and he was attracted to the idea of doing it again. "I liked working with entrepreneurs, and I got kicks out of seeing things happen and helping people succeed," he says. Lanphear, he discovered, felt the same way, and both men wanted to remain involved with young consumer-products and service companies. "We felt we had a lot of very useful experience," Lanphear recalls. "We wanted to work with other Duraflames."
They began to discuss investing some of Berolzheimer's money -- not really as venture capitalists, more as consultants. Their notion was that they would identify two or three attractive businesses or start-up possibilities in the consumer-products and services areas and then work closely with the management. Having done that, they would then invite established venture capital firms to participate as co-investors.
To get the ball rolling, Berolzheimer and Lanphear began calling on West Coast venture capitalists during the fall of 1978. The reaction was not what they expected. Berolzheimer was amazed: Nobody wanted anything to do with consumer companies. "They admitted they had invested in consumer deals on occasion," he says, "a wine deal or a backpack deal. They had even done reasonably well. But really, they considered themselves technology investors." Among professional venture capitalists with engineering and financial backgrounds, he discovered that the response was universally negative. "They had been very successful, and they had grown up around the semiconductor business," says Berolzheimer. "With so many opportunities, they simply weren't interested in going outside of their comfort zones. The more venture capitalists we met, the clearer it became to us that getting people interested in consumer deals would be as hard as selling ice to the Eskimos."
These forays posed an interesting question: Who would finance the future Duraflames?
The answer dawned slowly, beginning over lunch one day at a restaurant in Palo Alto, Calif. Berolzheimer's guest was Burt McMurtry, a general partner with Institutional Venture Associates in Menlo Park and a man widely respected in the California investment community. The meeting had been arranged by Larry Sonsini, a well-connected Palo Alto attorney who had helped Berolzheimer negotiate the sale of Duraflame.
McMurtry's initial reaction was what Berolzheimer and Lanphear had come to expect of venture capitalists: He himself wasn't interested in investing. Evaluating a consumer-product deal, he told them, "demanded a totally different set of kneejerk reactions from technology investing. The marketing and distribution strategies are entirely different." He simply didn't want to dilute his efforts. Even as he spelled out why he wasn't interested, however, he offered Berolzheimer and Lanphear some useful counsel. They should go out and do a fund of their own, he said. There was no reason why bright people with their kind of experience couldn't produce a very adequate return by investing in consumer products. McMurtry offered to direct them to some prospective investors, but he warned them that they would have a difficult time raising money.
Several months later, Berolzheimer and Lanphear took McMurtry's advice and resolved to become venture capitalists -- and quickly found that his prediction about fund-raising was all too accurate. They spent most of 1980 traveling around the United States and Canada, looking for limited partners. To money managers at pension funds, insurance companies, and banks, they talked about their record as entrepreneurs and their plans as venture capitalists. They conceded that some of the consumer-products companies they expected to invest in might never go public. Nor was it likely that these companies would produce the types of extraordinary gains investors had seen in companies like Digital Equipment Corp. and Apple Computer Inc. But going public was by no means the only way to realize capital gains. "We explained that lots of consumer businesses are sold at very nice multiples to large companies," Berolzheimer recalls. "Our own experience with Duraflame was a perfect example."
Berolzheimer and Lanphear used similar arguments with corporate-development officers at more than a dozen consumer-products companies. Beyond the investment opportunities, they argued that Early Stages offered a "window" for corporations on new product and diversification possibilities. "It wasn't unusual to have to go back and see prospective investors four to six times," remembers Lanphear, who spent four months operating out of New York City. "It was a very difficult sell."
But, gradually, investors started to sign on. The first commitment came from General Electric Co.'s employee pension fund, "We liked the fact that Berolzheimer had founded and built a successful company," says Janet Hickey, GE's manager of private placements and venture investments. "His expertise in marketing was very impressive, and we felt that it would give him a lot of credibility with other entrepreneurs." Over the next several months, a dozen other investors, including Gillette, Nabisco Brands, and the pension funds of Citibank and Sears, Roebuck, agreed to become limited partners. By February of 1981, Early Stages had promises of about $12.7 million in venture capital.
Having raised the money, the next challenge was to locate the deals. Berolzheimer and Lanphear were based in San Francisco, but they were prepared to respond to situations wherever they found them. As it happened, the first company Early Stages selected was one that Berolzheimer himself helped launch in 1979.
Homestead Provisions Inc., as the company was called, was in the business of creating a new type of snack food based on San Francisco sourdough bread.The product concept was one that a consultant had presented to Berolzheimer prior to the sale of Duraflame. Berolzheimer had liked the idea, in part, because it provided another opportunity to test his marketing skills. "It wasn't another potato chip; it really was a new product category," he explains. Because sourdough bread is a regional specialty, moreover, he thought it unlikely that a large food company would come out with a directly competitive product -- until the idea caught on, that is. Nevertheless, he saw the potential for a national market and, as with Duraflame, he wanted to build a brand (in this case, Emperor Norton Sourdough Snacks) before the competitors arrived. "The whole snackfood category was growing, and the product tasted damn good," Berolzheimer says. Once a brand was established, the goal would be to sell Homestead for many times the initial investment.
So Early Stages got off to a quick start with Homestead. Then it hit a drought. During 1981, the partners saw more than 200 proposals, about half of which were referrals from other venture capitalists. Berolzheimer, Lanphear, and their associate, Woody Kuehn (who had also worked at Duraflame), talked to many of the entrepreneurs, but they rejected nearly all of the ideas. "In any deal, we wanted to see a good product, a solid marketing strategy, and qualified people," says Berolzheimer. All too often, the projections for the size of the business were too low to justify the partnership's working minimum investment of around $250,000. In other cases, the entrepreneurs lacked sufficient management experience.
But even when the Early Stages team identified promising opportunities, they still faced the challenge of finding co-investors. "In case a company needed more money, we thought it was a good idea to have at least one other venture capitalist involved," explains Lanphear. One by one, they lined up the co-investors they needed and, in early 1982, Early Stages began putting money into a series of deals.
One deal involved Thomas E. Wolfe Co., a start-up company that made men's slacks. Wolfe's two founders had recently left Levi Strauss & Co. Their idea was to sell ready-to-wear trousers, precuffed or hemmed, through better department stores around the country. Jack Wolfman and his partner were convinced that the jeans craze had peaked; millions of men from the ages of 28 to 44 were now looking to buy dressier pants, they said -- pants that didn't have to be altered.
The Early Stages general partners were leery about investing in anything as volatile as an apparel company. "Apparel deals scare the hell out of me," Berolzheimer says. But when they finally sat down with the San Francisco-based founders, Wolfe's approach seemed a lot less risky than they had feared. To begin with, the product line wouldn't be particularly fashion-sensitive. It would emphasize traditional cuts and fabrics. Berolzheimer and Lanphear were also reassured by the fact that Wolfe's founders planned to invest some $200,000 each -- a substantial chunk of their personal capital. And they found comfort in the favorable response Wolfe was receiving from U.S. Venture Partners. One of its top men, Stuart Moldaw, had spent years as an executive in the retail clothing industry. "Moldaw was satisfied that the concept of the business made sense," says Berolzheimer. "We felt we had two founders who were capable of building a business." The initial investment was $400,000.
During the winter of 1982, Early Stages invested in another start-up, this one making devices for vacuum-packing food. Lanphear believed the vacuum packer could become another Cuisinart, the device that launched the food-processor rage. Then there was the business that wanted to sell a new vitamin for runners, which would be marketed through sporting-goods stores. It was launched by two entrepreneurs who had already taken an insect repellent named Cutters into the mass market. Berolzheimer thought they had the experience to build another brand name.
By all odds, the strangest enterprise they invested in was the obscurely named Telophase Society Inc., a San Diego-based cremation service that planned to open offices nationwide. In England and California, cremation was becoming more popular, and elsewhere in the United States there was the potential for growth. "Most venture capitalists rejected this deal right away," Lanphear recalls, laughing," and Michael didn't like it either. But eventually he went along. Nobody thought we'd be investing in death. But we learned never to say never." In that spirit, Early Stages also agreed during this time to back Mark Weissman, the man from Boston with the shampoo for swimmers.
As the partners became active venture capitalists, their marketing know-how began to attract entrepreneurs who were looking for more than money. In June of 1982, for example, Berolzheimer and Lanphear got a telephone call inviting Early Stages to participate in the initial round of financing for Businessland Inc., a new computer retailing chain based in San Jose. The company had been started by David Norman, founder and president of Dataquest Inc., a market research firm specializing in computers.
With his numerous high-tech connections, Norman was having no trouble with money, which he had already raised from the likes of the Mayfield Fund, Bessemer Venture Partners, and Oak Investment Partners. What he really wanted, however, was some help in understanding the retailing business -- specifically, how to identify and meet the needs of Businessland's customers. On the advice of Palo Alto attorney Sonsini, he contacted Early Stages.
Berolzheimer and Lanphear had considered computer retailing deals before, but Businessland's plan seemed more focused than others. Rather than trying to serve the broad market, the new chain was aimed at business customers only. In order to build a strong presence in that market, Norman felt that Businessland would need to deliver quality service and training, as well as the right hardware. So when Early Stages signed on as an investor, he asked Berolzheimer to serve as a director with a particular mission: to represent the customer.
Berolzheimer has done just that, proceeding much as he did during the 1960s with the pencil-wood customers.Last February, for example, he visited Businessland's outlets -- and those of its competitors -- in Phoenix and Los Angeles. On his return, he sent Norman a series of memos commenting on how the stores appeared to the customers. Among other things, he questioned whether Businessland's store managers and salespeople were spending enough time outside of the store, getting to know potential customers. "Most people think of retailing as bringing customers into stores," Berolzheimer says. "But in order to establish relationships with businesses in the community, Businessland has to do more than that. It's awfully easy to get caught up in the growth. But I keep bugging management to make sure they don't lose sight of who the customer is and how he may be changing."
Since the Businessland investment, Early Stages has participated in other service-oriented deals, including one that came to it through U.S. Venture Partners in May of 1983. The company was a new restaurant chain called Bullwinkle's Inc. Besides food, Bullwinkle's featured video games and stage productions with life-size, three-dimensional cartoon characters -- a formula reminiscent of the ill-fated Pizza Time Theatre Inc.
The first restaurant was up and running in Santa Clara, Calif., and its founder, Dave Brown, was looking for $5 million from venture capitalists to build about 10 more. Lanphear's gut reaction was negative. "I'm not a games person," he explains, "and I don't enjoy being in a mad-house with a bunch of screaming children." What's more, the troubles with Pizza Time had soured the investment community on such ventures.
On the other hand, Lanphear was impressed with Brown's track record in the restaurant business. Brown had been a vice-president with Marriott Corp. and had built its successful Roy Rogers Family Restaurants chain. So Lanphear looked closer at Bullwinkle's, and he began to see how it might succeed where Pizza Time had failed.
He started his research by spending a couple of Friday evenings at Pizza Time restaurants, where he found both the food and the service abominable. "It didn't surprise me that both places were almost empty," he says. Subsequently, he snooped at restaurant/entertainment centers operated by other companies. The more he and Berolzheimer learned about the competition, the more convinced they became that Bullwinkle's was more than hype and sizzle. "In the end," says Lanphear, "[Brown] knew that it all came down to good food and management." Early Stages decided to invest $500,000.
Once they invest in a business, the Early Stages partners try to provide as much assistance as they can. Berolzheimer, Lanphear, and Kuehn each serve on the boards of several portfolio companies. But beyond their formal relationships, they play a variety of roles. At Eljenn, the shampoo company, for example, Berolzheimer put Weissman in touch with marketing consultants and strongly urged him to do mass-market testing on UltraSwim a year earlier than scheduled. "I wanted him to stick his nose into the business so he could get as much experience as possible." The tests were encouraging, and -- one year after UltraSwim appeared on retail store shelves -- Eljenn signed a "six to seven figure" licensing deal with Shulton Inc., which markets Breck shampoo. As for the Businessland investment, Early Stages's investments of $750,000 recently had a paper value of more than $7 million, following the company's initial public offering last December.
Not all of the portfolio companies have been so successful. Last year, Berolzheimer personally took the reins of Homestead, the snack-food company, until he found a new chief executive officer who could rebuild the business. Homestead was suffering from major distribution problems, and it was losing money on slumping sales of about $500,000. After the distribution difficulties were identified, Berolzheimer and the new CEO, Jim Rueter, decided to try a different -- and more expensive -- system of direct stored delivery. Instead of relying on independent food brokers, Homestead signed a contract with a snack-food distributor. Rueter is appreciative of Berolzheimer's retailing acumen. "Michael knew a lot about distribution from his days with Duraflame. He knew that in order to sell a product, you had to get it on the shelf." Lately, sales have increased to a yearly rate of about $2 million.
But will Early Stages succeed in earning rates of return comparable to those enjoyed by technology-oriented venture capital firms? The results won't be in for several years. The original 10-year partnership extends until 1992. "This is not a get-rich-quick business," says Berolzheimer," and we know we can't win on every deal."
Nevertheless, Berolzheimer and his partners are confident enough that they are now raising money for a second 10-year partnership. This time the goal is $20 million. They hope to add a dozen or so new companies to their portfolio, and they plan to work with all of them, helping to build brands and create new value. "Nobody thinks we're crazy anymore," says Berolzheimer. "We've already shown that we aren't a bunch of country guys. But in this business, making money is really the only yardstick. Our feeling is that as long as we're professional about the process, the results will take care of themselves."
As it happens, Berolzheimer and his brother will have a chance to prove the point with a company near and dear to their hearts. It is actually an older company that did very well in the 1970s, creating a product and a brand name where none had existed before. Then it was taken over by a large company and fell on hard times. The Berolzheimer family took control of it in 1982.
The Company's name is Duraflame.