Aah, Those Were The Days
SIX YEARS AGO, THE ENTREPRENEUR listening for the music of opportunity amidst the din of economic disaster had to fine-tune his receiver -- or surrender to the static. Dial in any wavelength and there were few clear signals one could confidently decode. Who knew, for instance, whether start-up ventures would have access again to cheap capital -- or the primelending rate would continue to flirt with 20%? Who could predict with certainty, say, the shake-up in the airline industry that deregulation would cause, or how cost-control legislation would revolutionize the health-care industry?
In putting together the INC. 100 list of the fastest-growing public companies, however, we couldn't help notice the large number of companies born during this era of uncertainty and unrest. We wondered: Did they know something nobody else knew? Hear things no one else heard? Have a crystal ball hooked to a rooftop dish? Punching our own playback button, we decided to rewind the tape and listen once more to the background noise so dominant at the beginning of the decade. Some surprising sounds emerged.
Nineteen eighty, you remember, was a Presidential election year, and the air was filled with debate and despair. Followers of the Ayatollah Khomeini held 52 Americans hostage in Iran. World oil supplies were short, tempers shorter. As the political season began in earnest, President Carter started arguing with Ted Kennedy, Kennedy argued with Ronald Reagan, Reagan argued with Carter, and all of them argued with Paul Volcker, who wasn't even running for office. Economists spoke of supply-side theory and reindustrialization, yet the enduring images beamed back to the electorate were of a U.S. President omitting crucial sections of his anti-inflation address when two pages of the speech inexplicably stuck together, and of a Vice-President-to-be labeling his future boss's theories "voodoo" economics.
Actually, as Mr. Bush himself might concede today, voodoo had a certain appropriateness for an economy by all rights more dead than alive. In 1980, consumer prices soared 13.5% and the prime interest rate climbed past 20%, higher than ever before. Corporate profits fell about 9% and productivity 0.5%. Businesses were failing at the rate of 42 per 10,000 concerns, up from 28 the year before -- and up again, to 61, in 1981. Energy costs hit an all-time peak in 1981, six and a half times their level of 11 years earlier. Companies shopping for start-up money in 1980 were further hampered by a general lack of venture capital (a total of only $1.1 billion, compared with $2.8 billion in 1983) and an anemic initial public offering market ($420 million raised by venture capital-backed firms, versus $3 billion three years later).
Where so many heard only the buzz of bad economic times, however, others marched forward to a different sort of tune: the tune of opportunity. For Forum Group Inc., the #1 company on this year's INC. 100, it was the opportunity to move nimbly from the auto-parts business to health care and to the burgeoning nursing-home market. For Durakon Industries Inc. (#78), maker of bed liners for pickup trucks, it meant capturing a commanding (60% to 70%) share of a market expected to continue growing dramatically. For VLSI Technology Inc. (#9), it was the ingenuity to adapt product to market so swiftly that more than half its 1985 revenues came from products introduced during the same year. And for Jet America Airlines Inc. (#24), it was seizing the opportunity offered by deregulation to establish full-service routes to a variety of midwestern and southwestern cities out of Long Beach (Calif.) Municipal Airport.
Whatever their business and whatever the economic conditions when they started, companies on this year's list and on lists past have all had a much more important common characteristic than breakneck growth. They have, as individual companies and as a group, provided a blueprint of the major business opportunities provided by the American economy over the past decade, opportunities created by vast changes in technology, politics, and social and economic policy.
Look at the Fortune 500 and you won't find such ready evidence of new opportunity. The Fortune list is a rich anthropological dig into another era of American business history, a time when the steel, the auto, the chemical, and other heavy manufacturing industries made the United States the world's preeminent industrial power. You won't find any auto companies on the INC. 100.
Look at the INC. 100 lists since the first was published in 1979, and you'll have a tour of recent business history -- and, perhaps, a glimpse of the kind of companies that will dominate tomorrow's economy. Some will grow into big companies in their own right; others will be absorbed by Fortune 500 firms and influence their direction, as biotechnology companies have with some big pharmaceutical manufacturers. Still others will die because the opportunity they saw turned out to be a chimera, or because they mismanaged the brief chance they had.
The tour can start with the INC. list of 1979, when Federal Express Corp. (#19) was tapping a growing need for fast package delivery and establishing what became the model for a major new service industry. Or to the 1981 list, when Nike Inc. (#29) was taking advantage of vast social changes that brought new interest in fitness and leisure. Or look at the 1982 list and see Apple Computer Inc. (#1) establishing a personal-computer industry.
This year's list is no different. It is a window into the sea change taking place in the $387-billion health-care industry, where the major opportunities are now in cost control. Look at HealthAmerica Corp. (#20) and United HealthCare Corp. (#49), two of the leaders in health maintenance organizations (HMOs). Look at the other medical companies that provide such cost-cutting services as home health care, home diagnostic kits, and outpatient surgical and diagnostic clinics. Or look at the nine telecommunications companies that are seizing the opportunities created by the breakup of AT&T's monopoly. Or at the two airlines taking advantage of deregulation. Or at the 26 computer-related companies, including Ashton-Tate (#4), already a pacesetter in software, and Apollo Computer Inc. (#14), a leader in engineering workstations, a fast-growing segment of the computer market. Or at Expeditors International of Washington Inc. (#7), trying to exploit the growing need for fast delivery of business packages overseas. Will it be the next Federal Express?
If the success of these businesses seems routine today, turn up the volume and listen to the faint sonata that their founders heard before it played loudly enough for the rest of us.
Nothing would have been possible for Computer Telephone Corp. (#53), if not for the landmark Carterfone decision in 1968. The Federal Communications Commission began unraveling the AT&T monopoly in telecommunications by permitting the interconnection of non-Bell equipment to the Bell System's phone lines. Nine years later, a federal judge shattered another part of the monopoly by allowing MCI Communications Corp. to compete with AT&T in long-distance service.
It was an entrepreneur's dream, a multi-billion-dollar market opened to competition for the first time. Hundreds of small companies responded by manufacturing, supplying, leasing, installing, and servicing the interconnect equipment. "These companies found whatever piece of equipment they could and sold it on the basis of it being cheaper than what you could rent from AT&T," says Stephen Ide, who was then vice-president of operations for Rolm of New England, an operating company of Rolm Corp. "I remember sales calls in the mid-70s when you had to explain to customers that it wasn't illegal to be doing what you were doing [selling non-Bell hardware]."
In 1980, Ide and a few colleagues left Rolm to start Computer Telephone. The opportunity that had its genesis in Carterfone had changed substantially by then. "The small-business person was not getting the full spectrum of technological services available to Fortune 1,000 companies. They were dealing with people who couldn't provide the things we could -- the full spectrum of services. We were for small business, to get around the problem of people supplying little parts, but not the whole."
Ide started the company with the idea of providing comprehensive phone-system design, installation, and maintenance services, primarily to businesses with 150 or fewer phones. But it was a terrible time to start a business, opportunity or no."Our first two years were extremely tense," says Ide. "Thirty percent to 40% of our business is leased, and that makes it extremely interest-rate sensitive. Customers buying into our phone systems locked into fixed rates. But as interest rates rose, we had difficulty attracting new customers away from Bell's rentals. There were months [back in '82] when we sold or leased nothing -- zero. We began wondering if it took some sort of death wish to start a company when we did."
Though it sold itself as a sophisticated telecommunications firm, the company could afford only a single-line phone in its own office, a converted stable in Natick, Mass. "Here we were, selling very sophisticated equipment, but we couldn't even afford it for ourselves. We made every effort to keep customers away from headquarters in those early years," Ide says. To survive, Ide continues, "everyone had to be a salesman. Our single technician was not a salesman, but he used to telemarket for us."
Ide never spent much time speculating about a possible divestiture of AT&T's operating companies. "Back then," says Ide, "asking ourselves, 'What if AT&T deregulated?' was like asking, 'What if we could run wires to the moon?" Yet when divestiture came, Computer Telephone moved quickly to capitalize on an opportunity created by the change. It signed on as a partner with New England Telephone & Telegraph Co., a NYNEX Corp. subsidiary, to sell its facilities and services. "[These] are the same people we fought tooth and nail in 1980 to 1983," says Ide, a little incredulously.
"Our industry is at a transition point," he says. "In the next couple of years there will be three or four dominant players in any given region. Everyone's lowering profit margins to keep market share, but whether they can keep that market share is another question. We might wind up acquiring other companies or the deserted customer bases caused by company failures.
"It's still survival of the fittest."
Fittest." Now that word has a nice ring for Phil Bredesen, who founded HealthAmerica Corp. (#20) in 1980. The company owns and operates HMOs, which provide health-care services for a prepaid fee. Bredesen can make a healthy profit by keeping people fit. Even written in a doctor's scrawl, the prescription is easy to read: administer a lot of preventive medicine, and try to catch problems early. If hospital care is needed, treat patients efficiently and get them back home quickly.
That wasn't where the big opportunities resided in health care in the 1970s and early '80s. Third-party payers, including the federal government, reimbursed hospitals and other health-care firms for whatever services they provided to patients; with no incentives to hold down costs, national health-care expenditures rose from $75 billion in 1970 to $248 billion 10 years later. For investor-owned hospitals and other health-care companies, double-digit increases in sales and profits were routine. Meanwhile, employers were hard hit as their bills for health-insurance benefits soared about 20% a year.
Bredesen, an executive with a hospital management company, saw that this situation couldn't continue. "Around 1980, the health-care field in general seemed ready for new approaches," he says. "Everywhere, you heard a whole chorus of employers' complaints about health-care costs." And no wonder. "Hospitals were doing anything to get patients to stay in longer. I mean, you'd get a woman in maternity for a normal delivery, no complications -- and if she was still there on the third night after giving birth, the hospital would throw a steak dinner for the husband and wife."
Bredesen started HealthAmerica in 1980 with just $50,000 in seed capital from a quartet of private investors and a $250,000 line of bank credit. Venture capital was so tight that he didn't even bother to try. "Starting out with more money might have made us fatter and happier," he says, "but I'm not sure that would have been good for us. If you're starting out to run HMOs and you've got only $50,000, you do everything as if every cent counted -- which it does."
HMOs have been operating in the United States for half a century, but Bredesen moved into the market at just the right time. After passage in 1973 of a federal law promoting them, the number of HMOs increased 214% to 226 by 1980. But many were badly run and losing money. "A lot of the HMOs were starting to fail, and there was a feeling that if Reagan got elected, there would be an even greater drive to pare down costs," says Bredesen.
HealthAmerica got contracts to manage sick HMOs, with an option to purchase. But the gathering storm over health-care costs was changing the market faster than Bredesen had figured. One change was that employers, trying to hold down the rising cost of benefits, were pushing more and more workers into HMOs. The second change shook the industry to its core. In 1983, the government threw out the cost-plus method of reimbursing treatment of Medicare patients, replacing it with a schedule of fixed fees for each diagnosis. Now hospitals lost money by keeping patients too long. Only the most efficient hospitals -- those that conducted fewer tests and sent patients home faster -- could make money.
The new reimbursement policy brought a revolution to health care that you can see today: the average patient stays in the hospital fewer days and the percentage of empty hospital beds has increased. Since idle capacity is as bad for hospitals as it is for steel companies, such for-profit hospital chains as Humana Inc. are locked in an increasingly hot battle to attract patients. Their strategy: start or acquire HMOs and walk-in medical offices -- and use them to funnel patients into their hospitals.
"A window we had thought would be open wider, for longer, was closing fast," says Bredesen. "When we started out, we thought we had, oh, five or six years. We began to see that we didn't.The market was getting flooded." So HealthAmerica shifted strategy, acquiring and starting HMOs instead of just managing them. "We acquired some that were in worse condition than we would have wanted, that we probably wouldn't have bought if time had been on our side -- but they were available, we could get them, and we had to establish our presence in the market in a relatively short time." By early 1986, HealthAmerica owned or managed HMOs in 38 markets, with an aggregate enrollment of 895,000 patients. With revenues of $462.8 million and earnings of $11.5 million, it is now one of the largest operators of HMOs.
The same big move to contain health costs created an opportunity for James Sweeney. In 1979, Sweeney, who had spent four years as a health-care consultant for Arthur Young & Co., founded Home Health Care of America Inc. to deliver complex medical support services to patients at home. "My background in the industry gave me more of a macroview," says Sweeney, "but when we started, there was still such a strong bias toward hospitals that we didn't get a dollar's worth of [carrier] reimbursement for the services we offered. That situation and the malpractice issue made venture capital people very skeptical of us -- in fact, the first eight or nine turned us down. But logic was on my side. I knew something had to give within the system. Except for Medicare, the last big wave of federal legislation had come in the 1930s. Since then, everyone had been well served but the patient."
The company, which became profitable in its second year, has introduced such services as home chemotherapy and home antibiotic infusion therapy. It was positioned perfectly for the cost-control move that resulted in patients leaving costly hospital beds much sooner than before -- leaving hospital beds for beds at home, where Home Health Care could pick up the treatment.
Sweeney didn't stop there. Last year, Home Health Care acquired two companies, exploiting different opportunities in medical cost control. One, renamed America's Pharmacy Inc., feeds off the home-care division by providing drugs and other medical products by mail order. The other, Health Data Institute Inc., helps insurance carriers and big companies pare down their medical costs. It provides analysis and management systems to prevent unnecessary expenditures and inappropriate use of medical services. Folded into a holding company called Caremark Inc. (#76), the three businesses generated sales of $74 million and earnings of $7.4 million last year.
Caremark must grow to $500 million by 1990 just to survive, says Sweeney. "When you look at the $5 billion to $6 billion spent annually on home health care in this country and realize no one company has more than 1% of that market, you have to believe that consolidation within this industry has only begun. I expect about 15 'supermeds' to emerge within the next 5 to 10 years, and it's my job to stay ahead of the power curve."
For at least one INC. 100 company, staying ahead of the power curve is more than a turn of phrase, it's a way of life -- albeit an increasingly tenuous one. Identifying an opportunity and exploiting it are not always enough for an entrepreneur. The market that creates an opportunity can take it away, too.
It all looked so promising once for Solar Age Industries Inc. (#27), of Albuquerque. When it was founded in 1979, the price of oil was approaching its all-time high. Federal energy tax credits gave consumers an incentive to buy solar equipment, and enough did so to spur the growth of the industry from 45 companies in 1974 to more than 200 a decade later.
Ronald L. Wilder, a distributor of American Indian art, helped start one of those companies, Solar Age, after he saw a window solar collector at a home show. "Everybody was looking for energy-saving devices," says Wilder, the president. "The news media made everything look devastating, every paper or magazine you opened, every TV or radio you turned on, there it was. I think that just about everybody in the country was worrying, 'What's going to happen to my fuel bills?' I thought you could put a bunch of these [solar collectors] on a truck and go up and down the street and sell 'em like watermelons."
They sold well enough to launch Solar Age to $15.3 million in sales last year. But this year the bottom has fallen out of the market. The federal energy tax credits that made homeowner investment so attractive expired at the end of 1985, and Congress has been wrangling over an extension. U.S. crude oil prices have plunged from more than $36 a barrel to less than $14 in March, allaying concerns about energy costs and widening the competitive gap between oil and solar. Experts predict that half or more of the solar industry will fold if Congress doesn't help.
Will Solar Age be one of the casualties? "There's no way for me to minimize the impact, because it's there," says Thomas D. Taylor, the executive vice-president and chief financial officer. Sales in 1986 are down 65% from last year. In response, the company has started cleaning out its sales force."It's real easy for salespeople to get lazy and begin to rely on tax credits to do their jobs for them," says Wilder. "Then the credits go, and they don't know how to handle it.We've had to let some of the old sales staff go and bring in new people who never heard of the words 'tax credits." Solar Age is diversifying, too, by making a prefabricated greenhouse-cumsunroom that attaches to a house.
Like so many companies on this year's INC. 100 list, Solar Age was conceived out of the major social and economic forces roiling the nation. Now its opportunity may be disappearing as convincingly as it once appeared. That is one of the major risks of being an entrepreneur, listening as you must to the changing music of opportunity without the capital base and diversification that cushions large companies. In good times or bad, the sound never ceases.
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