Can appliance-control maker ACT Inc. become both the low-cost producer and the high-quality provider?

In a business in which success has eluded the likes of Texas Instruments, National Semiconductor, and Motorola, Wallace Leyshon, the founder of two-year-old Appliance Control Technology Inc. (ACT), optimistically expects his company to succeed.

In an old-line industry in which potential customers -- companies with familiar brand names such as Whirlpool, Tappan, and General Electric -- usually take years to incorporate new product features, Leyshon brashly claims ACT can get its components designed into products within months.

In competition with rivals who do their manufacturing in Singapore and other low-wage locations, Leyshon confidently predicts that he'll beat their product quality, service, and prices by using stay-at-home U.S. labor.

Is Leyshon naïve? Just hopeful? Or does he know something that the others don't?

ACT, Leyshon's first solo business venture, designs and manufactures microprocessor-based controls for major kitchen and laundry appliances -- the electronic buttons and panels you use to make them work. The challenges confronting the company are prodigious. Its customers are the large, conservative U.S. and European corporations that manufacture the appliances, and persuading decision makers at such places to take a little company's claims seriously is a major hurdle for Leyshon and his crew. And the almost revolutionary ambitiousness of those claims does not make clearing that hurdle any easier.

ACT, promises Leyshon, 39, who has education and experience in management and engineering, will be the low-cost producer of electronic controls. Aggressively reducing its price will not only assure his company's entry into the market, he says, it will greatly expand the size of the market by helping to make electronic controls price-competitive with old-style electromechanical knobs and dials. But at the same time that he touts his company's lower prices, Leyshon claims that ACT delivers measurably higher quality than the competition and demonstrably better service. And one other thing: Leyshon says that ACT will make the entire appliance industry more responsive to consumer demand by changing the working relationship between vendors and their appliance-manufacturing customers.

That's an awful lot of challenges for any company -- but especially the youngest in the business -- to take on all at once.

In 1986 Leyshon was running Motorola's electronic appliance-control business. While Motorola was the market leader at the time, appliance controls were just a small part of its booming automotive and industrial-electronics group, whose main business was producing computer controls for the automobile industry. Leyshon's division shared a manufacturing facility with its parent group, which meant that Leyshon had only dotted-line control of that function so far as his products were concerned. When Motorola management decided to move the entire manufacturing operation to Taiwan, Leyshon took issue. The move offshore, along with his feeling that Motorola wasn't adequately funding his end of the business, precipitated his departure.

In December 1986 Leyshon incorporated ACT, headquartered in Addison, Ill., a western suburb of Chicago. Eventually some of his former Motorola colleagues joined him: Brian Althoff, engineering manager at the appliance-control division, became ACT's vice-president for engineering and R&D. Les Jones, director of quality at the Motorola unit, became vice-president of quality assurance in the new business. In March 1987 the Electrolux division that makes Tappan microwave ovens wrote a $3-million-plus purchase order to become ACT's first customer. In September of that year ACT produced its first controls on a single, $1-million automated assembly line. Now, more than a year later, the company is operating two lines and contemplating a third.

Leyshon wooed Tappan with promises of lower prices, higher quality, and better service, the same line he uses on other prospective buyers. The issue is whether ACT can deliver.

Leyshon predicated his venture's early survival on its ability to drive the price of electronic controls down, thereby expanding the potential market and quickly building ACT's volume. Major appliance makers produce more than 45 million of the so-called white goods for the U.S. market annually. In 1986, maybe 15% of those appliances incorporated electronic controls. But 60% to 75% of the unit volume in any appliance line, Leyshon's research revealed, is in the midprice models, which electronics still hadn't penetrated. That's the market he wanted ACT to get into. By 1991, according to his projections, it will be worth some $750 million in the United States alone. There was also the European market, about the same size, to compete in.

To meet his objective, Leyshon elected to use three strategies. The first involved design and engineering; the second, manufacturing. And the third, maybe the riskiest, involved selling and marketing.

Before and during Leyshon's management, Motorola's appliance-control group had concentrated on designing products that were proprietary to each of its customers. ACT's design, Leyshon decided, would aim for increased standardization. That doesn't mean that its controls will look alike to consumers who buy, say, different brands of microwave ovens incorporating the ACT product. They won't even look the same from model to model within the same brand. Higher-priced ovens will still have more features -- a defrost cycle or a meat-temperature probe, for instance. But in the ACT design scheme, underneath the touch pad, there's the same chassis, same microprocessor, and the same components mounted on the same printed circuit board. The differences lie mainly in the software that's embedded in the microprocessor chip and in the panel face presented to the user. ACT's first product replaced 12 separate controls Tappan had been using on its family of microwave ovens with just 2 standard control models -- one for domestic ovens and the other for export. The electronic ACT product was priced at $16.80, about 12% less than the competitor's electronic control it replaced.

Standardizing its products within and even across appliance lines -- from clothes washers to dishwashers, say -- will reward ACT and its customers with substantial cost benefits, Leyshon argues. Instead of buying a million each of 10 different electronic components, for instance, ACT can buy 10 million of just one and get the higher volume price from the component maker. That's an important savings, since as much as 70% of the cost of the control is in materials. But nearly as significant in the Leyshon scheme are the savings reaped from lower inventory costs and shorter lead times. ACT and its customers will have fewer different parts to inventory; Just in Time inventory demands will be easier to meet.

If his design strategy breaches industry practice, Leyshon's manufacturing strategy violates all conventional wisdom. It's cheaper to manufacture in the United States, he insists, than to chase low-cost labor overseas. Cheaper in the high-wage United States? Yes, the way Leyshon figures costs.

First, he says, forget direct labor. It's not an issue. With automatic-insertion machines doing 70% (and eventually more) of the assembly work on ACT's PC boards, direct labor constitutes less than 10% of product cost. Anything the competition saves on direct labor overseas, says ACT engineering vice-president Althoff, they spend on duty, shipping, and airfreight: "It's a wash, we think."

In fact, from the point of view of engineering and manufacturing, there's no good reason to go overseas, no savings at all. An overseas plant requires additional management personnel. "We don't need a communications person at each end, a customer-service person here talking to a scheduler there; we don't need a plant manager there and a division manager here. All those communications are gone. One guy," says Althoff, "replaces two." Travel and hotel bills add up. At other companies, Leyshon has seen those T&E expenses come to $1 million a year.

But more important than all of these considerations, in the eyes of ACT's management, are the operational advantages to having engineering and manufacturing under the same roof. Those advantages, they argue, show up in product quality and service delivery.

Designer Jeff Krasnesky's CAD/CAM system and manufacturing's assembly lines are separated by one wall and a few paces in ACT's headquarters and plant. "I can't tell you," says Leyshon, "how critical it is to have those people able to work closely together." Communications, says Althoff, "is the biggest advantage. Manufacturing can walk into Jeff's office and say, 'Here's a problem.' With Motorola's plant in Taiwan, they can't send their Jeff over every time they have a problem, so the design center may never hear things like 'This doesn't fit,' or 'We're having to insert this by hand.' "

If he has a problem on the line now, says quality vice-president Les Jones, he can take it right to engineering, "and instead of Band-Aiding it, we can fix it." More than a year into production, ACT estimates a field failure rate of 0.25% on its controls, which is, according to Jones, "better than any other manufacturer." More impressive, the actual failure rate, Jones claims, is running 0.029%.

Customer service is also easier to deliver from stateside. "In this business," says Bob van Dusen, vice-president of sales and marketing, "the next generation could be tomorrow, and customers want it yesterday. If you go overseas, you're 16 weeks on the boat. If you're on the East Coast and I'm in the Midwest, I'm 14 hours away . . . I've taken a truck to Atlanta in the afternoon and gotten it there for the 7:00 a.m. shift."

ACT's domestic manufacturing strategy will lift skeptical eyebrows. But its protocol-defying marketing plan, in contrast, could irritate people who are important to the company's success. It's gutsy because it seeks efficiency at the expense of tradition.

Remember, ACT is not selling its product directly to consumers or even to retailers. It's simply a vendor to appliance manufacturers that may market their own brands or act as original equipment manufacturer (OEM) suppliers to such retailers as Sears, Roebuck & Co.

Traditionally, according to ACT's managers, vendors work from specifications. Sears, for instance, will tell Whirlpool's marketing people that it wants a new washer. The marketing people will generate ideas for product features based on Sears's suggestions, hand their ideas to the engineering department, which writes the specs and gives them to purchasing, which puts them out to bid. So, maybe 8 or 12 months after Sears decides it wants a new washer, the control maker finally gets a look at what the OEM's marketing people think Sears wants.

Now maybe the vendor can make a control with the features Sears wants and for the price Sears wants to pay, or maybe it can't. And maybe it has a completely wrong-headed notion of what Sears wants, given the number of people the idea has passed through. Or maybe Sears would want something different if it knew what the new technology could do and what its costs were. The point, says Leyshon, is that the current process leads to "wholesale miscommunication" and takes entirely too long.

Instead, for key components, the manufacturer's marketing people and the vendor's marketing people and, if Sears is involved, its marketing people, too, should sit down in the same room at the outset. They could make all their trade-offs then, and everyone would be working with the same information. That, says Leyshon, is how the Japanese and Koreans do it.

And that's how ACT is trying to do it. "My target," says van Dusen, "is the vice-president of marketing. He's the one guy you've got to sell. If you sell him, the VP of engineering is going to be predisposed to buy."

"We think it's important to American industry that everybody do this," says Althoff. "In Japan they can work out design issues in a week. In the United States it takes a year. The industry has to shorten the cycle."

But Leyshon and van Dusen have to persuade marketing VPs to talk to them, and they've got to assuage purchasing's hurt feelings. Whomever they talk to first, it's still purchasing that signs the POs.

In Leyshon's analysis of the competition his two-year-old start-up will face, Far Eastern companies don't yet play a big role. Japanese and Korean microwave makers do supply controls for ovens manufactured in their own U.S. plants. And a couple of Asian firms have contracts to supply U.S. appliance makers. But except for microwaves, offshore appliance makers have found entry to the U.S. market tough for two reasons. Their own domestic appliances are very different from those sold here, so they can't practice in their home markets on designs that are salable in the United States. Second, Leyshon's business plan points out, U.S. appliance manufacturers have kept their labor productivity quite high ($115,000 to $130,000 in sales per employee versus the U.S. manufacturing average of $64,000) and their costs low. Consequently, they don't provide the same wide price umbrella for imports that other industries -- autos and machine tools, for instance -- do.

Nor does Leyshon's plan anticipate much competition from semiconductor makers. Texas Instruments and National Semiconductor tried and failed to capture significant shares of the appliance-control market. They never took the time, in Leyshon's view, to understand the old-line industry they were trying to sell to.

ACT's chief competition comes from two groups of firms: electromechanical-control makers trying to convert their products to the new technology and electronic-equipment makers.

The first group knows the market well, he concedes, but he holds that it is difficult for companies organized around one technology successfully to make their own products obsolete by converting to a new technology.

The second group he takes more seriously. Motorola, which was the market leader when Leyshon left the company two years ago, has fallen behind a relative upstart, Digital Appliance Controls Inc. DAC is headed by its founder, Peter W. Sognefest, the man who originally put Motorola into the appliance-control business in 1977. Sognefest left Motorola in 1984 when he was promoted out of the job he had and wanted to keep. Like Leyshon two years later, he launched his own company. With projected 1989 sales of $25 million, DAC claims it will hold the largest single share of the electronic-control market next year. But unlike ACT, DAC manufactures overseas, sells its products through OEM purchasing departments, and stresses proprietary design and quality over standardization and low pricing.

The total U.S. and European market for appliance controls of both types now runs some $2 billion a year, about equally split between each side of the Atlantic. By 1991, Leyshon projects, electronic controls will account for close to half this market, and ACT, his business plan predicts, will have grabbed about 12% of the domestic market for electronic controls. It will also be competing in the European market, although just how European sales will be handled is still murky.

Capital does not seem to be a current problem for Leyshon, which is not to say that raising it was easy. It wasn't. Chicagoland is no Silicon Valley, Route 128, or Research Triangle when it comes to financing start-ups. "You mention start-ups in this community," Leyshon says, "and nobody wants to talk to you. Real-estate people, for instance, treat you like dog poop." He launched the company largely on the expectation that he would be able to attract investors. Indeed, with the first purchase order in his pocket, he was able to sell a first round of equity financing in early 1987 to raise $1.1 million. And with several months' production under his belt and a respectable order backlog, he raised an additional $2.2 million in a second round that closed in May 1988. A large portion of the second-round financing came through a venture capitalist, but even so, Leyshon and his key managers together have managed to retain 48% of the equity in the company. He expects to finance growth through cash flow and a line of credit. No further equity offerings are planned.

Estimated sales for 1988 were $7.2 million, less than half of his original business-plan projection, but not bad for a company's first full production year. ACT lost an estimated $900,000 in 1988, down from its $1.2-million loss in 1987 -- its first, partial operating year. Projections call for a $1.4-million profit in 1989, when sales, by the company's rosy predictions, will more than double. In fact, by 1991, Leyshon projects sales greater than $60 million, more than eight times 1988 revenues.

Besides the microwave controls sold to Tappan, ACT has added Maytag's Magic Chef division to its customer list. And it has development contracts in laundry and dishwasher products for Sears, Frigidaire, and White-Westinghouse.

But one thing isn't working as he planned. In his business plan, Leyshon said ACT would find eager customers among Japanese microwave-oven manufacturers with plants in the United States. After all, he reasoned, having a domestic supplier would help satisfy those manufacturers' Just in Time inventory demands. And the appreciated yen was making Asian-produced controls expensive to install in U.S.-made products. But the Japanese weren't as eager as Leyshon thought they would be -- or should be.

"It's a joke," he says, "I don't think they're the least bit serious about doing business with American companies. . . . The yen has appreciated 50% in two years, and I'm still not doing business with them. The economics don't add up."

For an update on this company, see Anatomy of a Start-Up Revisited: Making Money, Raising Money


EXECUTIVE SUMMARY

THE COMPANY
Appliance Control Technology Inc. (ACT), Addison, Ill.
Concept:
Manufacture electronic controls cheaply enough to break into midline appliance market (where they haven't been used before); achieve low-cost production goals by introducing standardization, a changed sales process, and onshore manufacturing to an industry that has embraced none of the above

Projections: Profits in 1989 of $1.4 million on sales of $18.9 million; 1991 sales of $62.2 million

Hurdles: Getting big-company appliance makers to change their habits in the ways ACT's concept calls for; keeping onshore manufacturing costs competitive

THE FOUNDER
Wallace C. Leyshon, 39, president and CEO
Before founding ACT, he was business director of the electronic appliance-control division of Motorola Inc., which had sales of more than $30 million, head count of 584 persons, and sales, engineering, and manufacturing facilities in the United States, Western Europe, and East Asia. He has a B.A. from Ohio University and an M.B.A. from DePaul University.

Somewhere along the line, Leyshon turned into a fervent industrial patriot -- which may explain his near obsession with onshore manufacturing. Bob van Dusen, vice-president of sales, recalls a call he and Leyshon made to the U.S. plant of a Japanese appliance manufacturer. "The Japanese told us we weren't smart enough to redesign their control," says van Dusen, "and you could just see the little American flags starting to pop out of Wally's head."

PROJECTIONS
ACT Inc. projected sales and profits
($ millions) Pretax income

Sales (loss)

1987 (actual) 0.9 (1.3)

1988 (estimated) 7.2 (0.9)

1989 18.9 1.4

1990 38.2 4.3

1991 62.2 7.9


WHAT THE EXPERTS SAY

FINANCIER
JAMES FITZPATRICK

Principal, Canaan Venture Partners, Royalton, Conn., formerly General Electric Venture Capital, experienced in electronic-control business with GE, Texas Instruments, and Motorola

I think ACT's notion of building onshore is right. It's absolutely correct that labor costs are a minuscule part of this product. Manufacturing in the United States should provide ACT with an enormous advantage.

Will ACT succeed? I don't know. You've got a very experienced team, people who know what they're doing. But I'm concerned that they may be trying too many things at once. A good company, a good entrepreneur, a good venture really does one thing very well. And here they're proposing to use a new design approach, a new marketing approach, and the onshore manufacturing approach -- three big bites. I don't think they're wrong on any of them, but if they flunk in any one area, they're in trouble. I'm not sanguine about their ability to survive, but I hope that they do.

COMPETITOR

PETER W. SOGNEFEST

President and CEO, DAC Inc., Hoffman Estates, Ill., electronic-control maker with 1988 sales of $15 million

I believe it will be very difficult for ACT to overcome the many obstacles that lie ahead. Leyshon started his company after less than six months' experience managing the appliance-control business at Motorola. It is difficult to learn any business in six months. Leyshon is on the right track in focusing on service and quality. However, a lowest-price strategy is seldom successful, especially when coupled with a high-cost factory (ACT's U.S. factory versus competition in Singapore and Korea). He's right to have a U.S. factory, but he also needs an offshore factory to meet the total needs of the appliance business. His major competitors, companies like mine, have factories in both places. And the DAC U.S. factory cannot compete with the DAC Singapore factory.

During my 20 years in this business, I have never seen Leyshon's sales approach work over the long term. The supplier must serve the needs of his customer's purchasing and engineering departments. The customer's purchasing and engineering departments are quite able to work with their own marketing organizations. It is necessary to sell to those who give the order in this market.

I think there'll be a capital problem, too. ACT has raised $3.3 million and plans to grow to $18.9 million through retained earnings. However, just licensing the required technology has cost my company $750,000. ACT will also need these licenses. If ACT has similar licensing costs and cumulative losses through 1988 of $2.1 million, it won't have a lot of money to support growth. Contrast this with $16.1 million in equity raised by DAC to reach $25 million in 1989 sales. The numbers suggest that much more equity will probably be required.

CUSTOMER

JAMES WEST

Executive vice-president, marketing sector, WCI Major Appliance Group, Columbus, Ohio, which buys from ACT and other control suppliers

Their sales approach is working here. Marketing people are working with ACT along with the purchasing and technical people. Can others copy that? I think they can, but at this point most haven't. This is a great marketing strategy for getting new business, but it's not without risk. What happens when you get the new business? A year after a control goes into a design, the purchasing guy is going to take that wonderful new system that ACT has developed with the marketing and engineering people and take it out for quotes -- "OK, industry, have at it, beat this price." That's the nature of the industry. It's very cutthroat. Given that, ACT will be in the position of continually having to defend business that it's already gotten. Your ability to gain business is only as good as your ability to keep business, and you do that only by keeping costs down and prices competitive -- great relationships won't do it. They've got a tough, competitive road ahead.

It's uncomfortable to think about how much of its competition is overseas. It's hard to believe only Wally Leyshon has been able to figure out that that isn't smart. But I'm relying on what he's said to us, which is that direct labor is indeed no more than 10% of product cost, and that's more than offset by the longer supply-chain issues. He's very committed to this made-in-the-U.S.A. strategy, and I'm on his side -- I hope it works. But he is all alone on that one.

FINANCIER
KYLE LEFKOFF

Venture associate, Colorado Venture Management Inc., Boulder, Colo.

The company's credibility, I think, is excellent, evidenced by a $3-million purchase order from Tappan before the first venture financing. To our minds, that's a real feather in Leyshon's hat. Because a guy who comes to me and says, "Hey, I've got this new product, would you be willing to put up some seed capital, and by the way I have a $3-million purchase order on the table," is a very impressive guy to us. That's the kind of guy you love.

Also, the entire team comes from what was the industry leader in the business, Motorola, so they're not reinventing this business. They've already made money at it; they just want to do it for themselves now instead of for a big company. And that's a story that appeals to a venture capitalist.

The projections look reachable given the size of the market and competitor DAC's experience. DAC reached $25 million in a couple of years. It got big fast, and venture guys like to see that, too. Here's a company that is, in a sense, an analog to ACT, and it shows that little companies can get into this market and make it work.

Would I invest? Obviously, it depends on price, but the answer would probably be yes. It looks like a good deal. I would have liked to have gotten in on the first round, not the second. I think ACT will get to pretty significant revenue fairly soon; the numbers are achievable. The plan is aggressive, but it has a team that looks like it can do it. Even if the company gets to $15 million the third year, that's pretty good. Do I think the company will succeed? Yes. My definition of success is 10 times the investment in five years, and I think they'll do it.

One nagging question, though: why is ACT in Chicago? This business could be anywhere. If I needed to build a factory, I'd go looking in the boonies and see who'd give me the best deal. There are places that would love this business. It's basic, hard-core, nonpolluting manufacturing. States like Colorado would have rolled out the carpet for him, given him a free building and equipment grants and tax breaks.