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."
