Hino & Malee Inc., a Chicago-based designer of high-fashion women's clothing, has urged some of its big-name department-store clients to buy less, not more, of its pricey duds. Healthcare Services Group Inc., a firm in Huntingdon Valley, Pa., that contracts with nursing homes, has twice called a six-month halt to its selling and advertising efforts, in an attempt to discourage new business.
Young companies, led by their founders, turning away good business and turning up cautious? This isn't the way entrepreneurs -- bold, brash risk-seekers -- are supposed to behave. Or is it?
Howard Charney thinks it is, which is surprising when you consider his own situation. He is a co-founder of 3Com Corp., a company that lives in a neighborhood -- Silicon Valley -- and works in an industry -- microcomputers -- where spectacular growth is commonplace. But Charney and his colleagues, 3Com chairman Bob Metcalfe and chief executive officer Bill Krause, don't fit neatly into the growth-at-any-cost stereotype. Charney, in fact, thinks that the entrepreneur-as-wildcatter is a myth perpetrated by business school professors.
That may be, but the professors are not alone in their mythmaking. The business press -- this magazine often included -- bestows its plaudits and notoriety on entrepreneurs who create the most from the least in the shortest period of time. The investment community, from venture capitalists to institutional portfolio managers, looks for growth the way college admissions officers look for high test scores, and places its bets accordingly. Entrepreneurs themselves, goaded by the press, the market, or simply by pride in their own accomplishments, frequently measure their success by sales-and-revenue curves, and forget about everything else.
The riskiness of such single-mindedness occasionally shows up in the headlines. Osborne Computer Corp., for a while the darling of Silicon Valley, went from startup to more than $100 million in sales in only a year and a half before winding up in bankruptcy court. Pizza Time Theatre Inc., brainchild of Atari Corp. founder Nolan Bushnell, grew at a compound annual growth rate of 171% for five years -- enough to place it for two consecutive years on INC.'s list of the 100 fastest-growing public companies in the United States -- before it, too, filed for protection under Chapter 11.
Such stories alone prompt doubts about top-line growth as a measure of business success, particularly when compared with profitability or productivity. When entrepreneurs and CEOs forget that growth is only one measure among many -- when they become fixated on growth and feel compelled by pride or ambition to emulate or top the growth of others -- that is when they get into trouble.
But avoiding trouble isn't the only reason for putting growth in its place. More important, for a healthy company, may be the long-term strategic value of controlling growth just as one controls other variables in the calculus of business. At any given time, no growth, slow growth, or just less growth may be what is called for, if only so that the pace can pick up in the future. Indeed, if holding back today is what will make tomorrow's expansion possible, then to hold back is only good sense.
Whether more than a few growth-oriented companies subscribe to this notion of good sense isn't yet clear. But at least some entrepreneurs believe that growth at any cost is precisely what their competitive situations do not call for. To control growth, they are willing to forgo selling opportunities, limit their market share, and keep money in the bank rather than spend it. The stories of three such companies show why.
Last April, Joan Collins, of "Dynasty," and celebrity designers Bill Blass and Giorgio Sant'Angelo joined hundreds of people from the Seventh Avenue fashion industry, all bedecked in the frippery of their trade, for a festive gathering in the Grand Ballroom of The Pierre Hotel in New York City. The occasion was the judging of the first annual More (cigarette) Fashion Awards competition for young designers.
Among the young designers present were Kazuyoshi Hino and Malee Chompoo. Hino, who uses his last name because, he says, Kazuyoshi is too difficult to remember, and Malee, who prefers her first, were one of five finalist designers or design teams chosen from among 250 entrants. They didn't win. But that was all right: The recognition they received at the gathering meant they had arrived in an industry in which status is everything. Their company, Hino & Malee Inc., was indisputably hot. And it was time, by some reckonings, for the pair to shoot for the moon, to create the next fad, to ride high on a wave of trendy fashion.
Hino and Malee, by common consent, have both the design talent and the imagination to go for such goals. But they chose not to try. In fact, the flattering attention they gained at the Pierre -- and that they have gained elsewhere on numerous occasions in the past few years -- didn't change one iota the way the shy couple does business. Just surviving in the fickle fashion industry is risky enough, in their view, and the two entrepreneurs have studiously avoided taking other chances with their infant enterprise. They would much rather have a solid small company than a shaky larger one.
Their conservatism shows up in any number of areas. Their company has limited its line to a relatively small niche -- designer sportswear -- in the huge garment industry, and to a distinctive style within that niche. It does no work on speculation: Contrary to industry practice, the Chicago company won't make a garment in its 14,000-square-foot North Side factory until sales representative Tom Hewitt produces a confirmed order for it. If orders exceed the plant's capacity to produce, the company may lose some sales. On the other hand, if orders fall short of expectations, it has invested no labor -- which at 25% to 30% is the largest single component of a garment's cost -- in unsold finished goods.
Financially, the company remains as close to a cash-based business as the two partners can keep it. They have financed the company's growth almost exclusively from profits. The only contributed equity in the business is the $2,500 each invested in the first few months to buy fabric for their first collection. A close friend loaned them enough cash to finance Hewitt's first selling foray to Manhattan; they have never borrowed from a bank.
"Next spring," says Hino, "even if we sell nothing, we don't owe anybody anything."
No retailer, no matter how prestigious its name, gets a shipment from Hino & Malee until its credit is approved. At the cost of some lost sales, but in the interest of undamaged profit margins, this prudence in trade-credit approval has kept the company's bad debt rate at less than 1% of revenues. Even if a store's credit checks out, Hewitt sometimes persuades store buyers to order less than they think they can sell. He has urged some chains to limit the number of their stores carrying the Hino & Malee label, focusing only on those in urban centers where more fashion-conscious women shop. "When stores like I. Magnin start pushing us into remote locations," says Hewitt, "it makes us a little nervous. So we're saying, 'Why don't you just keep us in 3 or 4, not 15 or 20, of your stores?"
There are sound business reasons for Hewitt's caution: Not all sales are necessarily good sales when a tiny company depends on giant retailers for 60% of its business. Department stores routinely ask garment-makers to take back unsold goods at the end of a season. Or they ask manufacturers to contribute "markdown money," cash to compensate the retailer for the lower margins it gets in end-of-season sales. Both of these are bad for the manufacturer's bottom line, and the larger the manufacturer, the more likely the retailer is to seek help. As a tiny business, Hino & Malee can plead a lack of resources should the likes of Bonwit Teller, Bergdorf Goodman, or Lord & Taylor raise the issue.
Growth is also an issue that Hino and Malee are struggling to resolve for themselves: It is a personal as much as a business issue.
Hino, 42, came to this country from his native Japan in 1975 and got a job in Chicago working as a pattern maker for a manufacturer of uniforms for Las Vegas casino workers. Malee, a year younger, left Bangkok in 1969 and was a design assistant with a high-fashion apparel company in the same building. When she lost her job he quit his, and in March 1980 they created the company and began selling women's sportswear, designed by Hino and sewn by Malee, from a tiny boutique in the corner of an upscale Chicago beauty salon. Within a year, they had been introduced to Hewitt, who became their full-time rep and moved his showroom from Chicago to the Manhattan fashion capital. Hino's "architecturally" inspired designs began to be shown in Bloomingdale's and other department stores. Sales in fiscal 1982 climbed to $512,000; in 1983 to $1.3 million; and last year to $2.1 million.
Despite these sales figures, Hino & Malee is still almost a mom-and-pop operation. It has no management organization, no strategic planning, and no articulated goals. Hino and Malee themselves are amazed by their success in just four years, and are at the same time frightened by the size and the momentum of the business they have created. They have no experience -- in finance, marketing, personnel management, or cocktail-party protocol -- and no formal training, either. With their soft, inexpert English, sometimes difficult for the ear to capture, often they can only indicate, not explicate, complex thoughts -- as when, for example, Malee says of their business strategy, "We just use our sense."
The pair started the company primarily to give expression to their design ambitions, and Hino, especially, worries that he will become too busy running the business to do the designing. They may hire a president, someone to manage the company, or they could sell the business and stay on in their creative roles. At this point they don't know what they want. But in the meantime, they aren't going to jeopardize their options by trying to move the company beyond their own capabilities, beyond what "sense," as Malee puts it, can manage.
"We could all have smiles on our faces staying between $2 million and $3 million [in sales]," says Hewitt. "We don't have to grow to $6 million. The larger you get, the more vulnerable you are."
The managed-growth strategy that Hino and Malee arrived at by default would make sense to Dan McCartney: A similar strategy has been part of his plan from the outset. Healthcare Services Group, the firm McCartney and Mel Mason founded in 1977, has no direct competitors; it has more capital than it needs; and its market is both receptive and practically untapped. In fact, the main thing -- the only thing -- holding Healthcare's growth rate in check is McCartney's insistence that the firm stick to its plan, which, while it drives the firm's growth, also constrains it. In his view, the single biggest threat to Healthcare Services's long-term success would be impatience, the temptation to short-circuit the plan. McCartney has proved a patient man.
Healthcare is in the business of selling a solution to a problem. Neither the problem nor the solution is terribly complicated; you just have to see them and recognize the business opportunity, as McCartney and Mason did.
The problem they recognized is that, in most nursing homes, the worst-managed department is usually housekeeping -- the people who scrub, clean, and polish. The head nurse has prestige, the chief dietician has prestige, but the top janitor does not. Usually, says McCartney, he is a former floor man who is good with a bucket and mop but has no management experience or training. Housekeeping, consequently, is frequently inefficient and ineffective, and is a constant source of niggling problems to nursing-home administrators.
The way to solve the problem, of course, is to replace the bucket-and-mop people with trained, ambitious managers who can hold their own with the nurses and dieticians while motivating the cleaning troops. McCartney figured out how to do that, and he and Mason built a company around the solution.
You attract ambitious people to the job, he reasoned, by making it an early step in a challenging management career, not the last step in a vocation that tends to attract people without other skills or talent. And then you train those ambitious people to do things your way. "I am of the opinion," McCartney says, "that in our industry there is no talent to steal."
After Healthcare signs a contract with a nursing home, it replaces the current chief housekeeper with one of its own trained managers. The working troops technically become employees of Healthcare, not the nursing home, but their wages, fringe benefits, union agreements, and so on remain unchanged. As far as they are concerned, they still work for the nursing home. "The only difference," says McCartney, "is the management."
Even if they have had some experience, all new Healthcare managers go through 60 to 90 days of training, beginning with the basics. They clean patient rooms, then public rooms, and move on to floors. They learn to hire and train new cleaning workers. They supervise specific cleaning crews. They learn administration. After three months or so, if their evaluations are good, they will be made assistant housekeepers at large facilities.
From there, a manager might solo at a smaller home, then take command of a staff of assistants at a bigger institution. Then he or she can progress through training manager, district manager, regional manager, and, as the company's geographic expansion proceeds, take charge of a division.
"We use the same mop handles as everybody else," McCartney says. "The difference is that we can provide a better manager than the facility itself can. Our guy knows that he can move on and up. The facility's own person is stuck there, or at another place just like it."
McCartney's idea works. Last year, its seventh, Healthcare earned pretax income of $1 million on revenues of $8.2 million, from contracts with more than 70 facilities in the Northeast and in Florida. Since 1980, its revenues have grown nearly 45% compounded annually, and net earnings have expanded at an annual compound rate of 100% over the same period. Just as significant, however, is the firm's 95% contract-retention rate. In seven years, only six clients have canceled or failed to renew their contracts, one of them because it went out of business.
The limits to growth for Healthcare have not been market-imposed. "Getting new business," McCartney says, "has been the least of our problems." With the graying of America, the nursing-home industry has expanded rapidly, and facility owners apparently are impressed by McCartney's standard argument. "A nursing home may spend, say, $250,000 a year on housekeeping," he says, "so I ask them, 'If you had a quarter-of-a-million-dollar business across the street, would you hire Jim the janitor to run it or somebody with some management training?"
Nor has a lack of capital slowed the firm's growth rate; it is, when things work properly, closer than even Hino & Malee to being a cash-based business. Most client institutions, McCartney says, treat Healthcare's fees just like a payroll expense, writing checks to Healthcare weekly or biweekly, and the firm, in turn, pays its housekeeping employees. If Healthcare has correctly estimated its own costs, it begins collecting a profit from every new client with the very first payment. "When we started the company," McCartney says, "we had to be profitable instantaneously because we had no money." And now it has almost an embarrassment of capital riches: Last year, Healthcare went public, raising $3.5 million.
Indeed the only limit to Healthcare's top-line growth has been the time it takes to recruit and train managers and build the management structure. But this limit is a significant one, and overstepping or ignoring it could be fatal to the firm. "In 1978," McCartney says, "I thought we had started to lose it." Healthcare had enough entry-level managers to staff the facilities it served, but their supervisors, the district managers, were stretched too thin. Because it takes about two years to train a new district manager, in McCartney's view, the firm had to slow down. It did, adding only three accounts that year.
In 1982, Mason and McCartney imposed a-six-month selling moratorium on themselves because, once again, the business began to tax management's capacity to manage. Eight new district managers were trained that year. The company has to lose only two or three contracts, McCartney says, to lose its reputation, "so, in retrospect, that [moratorium] was probably the most important decision we've made since going into business."
The shortcuts available to Healthcare are obvious enough. It could reduce the training time for new housekeepers by hiring people with on-the-job experience. It could increase the number of facilities each district manager is responsible for, and increase the number of district managers reporting to each regional manager. It could grow by acquiring other companies that deliver a similar service and using their management personnel. Any of these options would speed the growth of Healthcare, but might jeopardize McCartney's carefully thought-out strategy. McCartney has considered them, but has decided to stick to the original plan.
Sticking to the plan is a precept that 3Com would endorse -- along with Hino and Malee's preference for caution and profitability.
In October 1980, this unusual group of entrepreneurs began approaching California venture capitalists with an unusual business plan. The group included 3Com's prime founder, Bob Metcalfe, formerly with Xerox Corp.; Charney, who is an engineer with an MBA and a law degree; and two others. The plan, instead of projecting spectacular growth and early capture of market share, predicted that the year-old company's share of the potentially huge market for computer networking systems was going to decline, from 6.5% down to 5%, over the next five years.
Declining market share is not something venture capitalists like to see, and it is certainly not the sort of projection Silicon Valley entrepreneurs normally wave around when they are out raising equity capital. "The venture capitalists' reaction," says Bill Krause, now 3Com's president and chief executive officer, "was, 'Come on, what is this? We're looking at maybe a $3-billion market, and you guys are only going to be an $80-million company?"
Still, the venture capitalists came across with $1 million in first-round financing, largely on the strength of the reputations of Metcalfe and his Gang of Four, as the founding group became known, plus a fifth -- Krause, a 14-year veteran of Hewlett-Packard Co. and general manager of HP's General Systems Division, who was recruited by Metcalfe to be 3Com's president. "We liked the team," says Gib Myers, a venture capitalist investor who now sits on 3Com's board, "but we had no great insight about whether Ethernet would win the race."
Metcalfe, with others, had invented Ethernet at Xerox in the early 1970s. It is a system for linking all of a company's computers and computer peripherals (e.g., printers) within an office building into a so-called local area network system (LANS). Networks allow machines to talk to one another, permit people to use electronic mail, let personal-computer users tap data stored in mainframe computers, and encourage other innovations in intraoffice computer use. But before Ethernet or any of the other competing LAN systems could be exploited commercially, there had to be lots of computers that needed connecting. Until 1981, there weren't. "Ethernet was a technology ahead of its time," says Krause. It was a solution waiting for a problem.
Before 1981, companies typically had large mainframe computers, or at most a few minicomputers. There was some business to be done in tying these machines and other terminals together. But Metcalfe and the Gang of Four decided in 1980 to convert 3Com from a consulting firm into a LANS manufacturing business, based on their conviction that the market would change. They didn't know when it would change, or who would change it, but somehow, Metcalfe was persuaded, 16-bit personal computers would become ubiquitous. When they did, people would want to link them together, and that would define 3Com's main market.
There were other, conflicting theories. Some people in the industry thought the future lay in linking more terminals to larger minis and mainframes. Others thought the future was in linking together the small, inexpensive 8-bit machines produced by such companies as Apple Computer Inc. And there were other LANS technologies besides Ethernet. So 3Com had plenty of options it could have pursued, some of which promised earlier results and quicker payoffs than the company might achieve by waiting for a hoped-for market to materialize.
"It came down to the two kinds of strategies that one can take in starting a company," says Krause. "In one you build up a large amount of fixed overhead in your engineering, marketing, and manufacturing, and bring your product to market; the risk is that there won't be enough demand for your product to cover that overhead. The second strategy is you let market demand determine your rate of growth and you let your shipments lead your expenses. The risk you take there is that the market may run away from you because you haven't invested fast enough."
3Com chose the latter strategy, in large part because of Krause's conservative predilections.
"Bill Krause might offend some people in our business," says Dick Kramlich, a venture capitalist and one of 3Com's first-round investors, "because he's a little too orderly for them."
Krause's orderliness at 3Com meant that things were done according to plan, not according to impulse. It wasn't always easy -- for Krause, or for the rest of the company.
Just five months after coming aboard as president, for example, Krause imposed a four-month survival plan on a crew that theretofore was accustomed to living on its entrepreneurial exuberance. Sales of the company's interim products to the limited market that existed in the summer of 1981 hadn't risen as much as the company's monthly planning process, another of Krause's management tools, had anticipated. So Krause imposed a hiring freeze and created a list of specific objectives -- customers to be called on, orders to be gotten, distribution channels to be opened -- that had to be met.
Charney, currently 3Com's vice-president for engineering and then the vice-president for manufacturing, recalls the reaction: "People in the Valley said, 'Here's this little company that has a million dollars in the bank, that's supposed to be in this really hot market, and yet they're putting in place a four-month survival plan. These guys must be really crazy.' At the time, even I thought we were being paranoid. At first, just having a survival plan created a depression [in the company]. People would ask, 'Why are you putting me through this nightmare?' And Bill would say, 'You know, we don't have a problem today, but if we continue along this path, we're going to have a problem, which is going out of business. So we're going to follow this other path. We're going to tighten the belt, and I'm going to highlight those three things each of you has to do, and we're going to go out and do them.' Companies that are out of control never have survival plans. Why? Because they don't know that they need them."
When sales still didn't develop according to plan, Krause did something businesses in Ohio might be used to, but not those in Silicon Valley. Everybody in the company took a pay cut. "We developed our 15-10-5 plan," Krause recalls. "Executive committee members took a 15% cut; exempt employees, 10%; nonexempt, 5%. We felt that the people most responsible for the fortunes of the company should take the largest pay cut."
While all this was going on, IBM Corp. introduced its 16-bit personal computer and, with that one announcement, created the market 3Com had been waiting for. By the summer of 1982, 3Com's sales were back on track, and that fall its growth began in earnest. The planning, the patience, and the survival plan had all paid off. Now 3Com is on a growth track that, Krause projects, will take it to $100 million in sales by 1987, with a return on stockholder's equity substantially higher than it could have earned if it had consumed capital pursuing other, shorter-term markets, or if it had gone back to the capital markets instead of conserving the cash that it had.
The philosophy -- almost the corporate culture -- that led to this payoff now seems to permeate 3Com, and is reflected in what its executives say when they assess the slow-growth period of the past. "Bill," Charney says, "has an expression, which is, 'Do a few of the right things well.' Doing a few of the right things well is a very good way to run a business, because doing too many things will kill you. You don't have enough resources. Too many small companies die because they attempt 14 variations on six different themes. That's what3Com's business plan was -- a plan of too many of the wrong things done poorly. That's not to say that we were stupid; it's just to say that we had to grow up, learn to focus on what our business was about, and then concentrate on the two or three things that really needed to be done over the next 12 months."
"My view," says Krause, "was that long-term profitable growth was more important than short-term market share. My theory is that you start out with a set of principles or beliefs, and from those you begin to develop business strategies that are consistent.-My purpose in building a business is to create something that will live beyond me. I want people to say they want to join 3Com because it's the best managed company in Silicon Valley, so I needed to stick with some fundamental principles: Make a profit, serve the customer, achieve product leadership, and build a quality organization. They became both conditions of and constraints to our growth. We couldn't take on too broad a market, for example, because how, then, could we be perceived as product leaders? Trying to do too many things might require us to grow faster than our principles would allow us to grow."
"Bill," adds Charney, "would say, 'We don't buy into the philosophy that we'll make profits tomorrow and suck cash today. It's just as easy to make a profit today, and we're not going to fall prey to that intoxicating thought, to put profit off into the future."
So far, the fiscal conservatism of people like Krause is only beginning to be reflected elsewhere in Silicon Valley. Top-line growth, points out venture capitalist Myers, is what creates "value" in a company's stock. "Maybe what's changed, though, is how you go about it." There is more pressure today, he acknowledges, to be smarter about not putting too much money into a company too early. And some companies themselves are chary of venture financing precisely because of the superfast growth rates typically demanded by venture investors (see "Why Smart Companies are Saying No to Venture Capital," INC., August, page 65).
To Charney's way of thinking, however, the lesson couldn't be clearer, both from his own company's experience and the experience of others. "Here's 3Com. It went public in the worst time in years, and its stock went up; it's acknowledged as being a very well-managed company; and it's growing at 300% a year, or whatever. And so you say, 'Well, didn't you miss? You could have grown at 500% a year.' Yeah, yeah . . . but I'm not embarrassed to go to my investors and say that we grew from $4.7 million to $16.7 million this year . . . and we had 15% operating profit in doing so. And I'm still here, and the turnover is low. Maybe there's some lost opportunity, but I find it hard to believe that it's worth the risk."
Other companies' trajectories, he notes, bear out this conclusion. "Fortune [Systems Inc.] made a bet on one computer system with one technology, high flying. They said, 'We're going to staff up to 250 people; we're gonna raise $26 million. I don't care if we are sucking $6 million a month in negative cash flow.' 3Com took a completely opposite point of view. We said, 'We're going to raise $1 million. Then, when we kind of think it's all gone, we'll raise another $2 million. Meanwhile, we'll come out with this little tiny product and see if we can sell it. And if somebody buys it, that'll be great.'
I would say that the probability [of success with Fortune's approach] isn't worth the risk. We have Osborne and Victor and Fortune and Eagle. So we have three or four resounding didn't-make-its. Atari is another. Pizza Time Theatre is another." But what about the ones that succeeded -- Apple Computer, say, or a more recent hot number like Convergent Technologies Inc.? Charney is unshakable. "And then we have Convergent, one which appears to have made it and also took that risk. I don't want to take the Convergent risk as an entrepreneur, that all-or-nothing risk. I just don't think it's worth it.
"The reason I don't is that a more conservative, lower-flying, more controlled growth, more wait-and-see approach has a higher probability of success. I believe it will get you there in the end."