The Small Chill
Can a start-up marketer sell proprietary appliances to college dorms and budget motels?
In September 1989 the Associated Press sent out a story about a novel kitchen device that had begun shipping the month before. "The next thing I knew," relates the contrivance's inventor, Robert P. Bennett, "my brother phones from Alaska -- he just saw my picture in the local paper. Then ABC News calls up, and Paul Harvey describes it on radio, and Cable News Network airs a TV item; we're in USA Today, the Chicago Tribune, The New York Times. I personally was interviewed live at least a dozen times." The most-asked question: are students really going crazy over the thing?
So crazy, Bennett predicts, that they will pay for some $90 million worth of them over the next five years. On top of that, Bennett is looking to collect $55 million from motels, another $5 million or $6 million from housing projects, and lesser six-figure amounts from the army and navy, business offices, and trailer camps. Indeed, in this, his first full selling year, Bennett anticipates revenues of more than $15 million, with net profits after taxes close to $1 million.
If everything goes as planned, every cent will have come by way of one rather unimposing item barely the size of a two-drawer filing cabinet -- the refrigerator-freezer-microwave oven that his new company, MicroFridge Inc., makes and markets. But couldn't any of us go to the corner discount store, purchase a compact fridge and a midget microwave, and spend less than the $429 that Bennett's tripartite unit sells for? Sure, but we'd likely end up with less capacity than his collective three and a half cubic feet -- nor would the components be spliced into the energy-saving circuit that is the MicroFridge product's sine qua non.
It's this now-patented circuit, initially devised with the help of some engineering friends, that positions MicroFridge for the customer niche Bennett spotted back in '86 -- anyone occupying cramped living quarters that are served by marginal electrical wiring. The current-limiting switch rules over the power draw of each component, so that when the 500-watt microwave is in use, the refrigeration system is automatically shut down. Even under multiple use, demand never exceeds a modest 10 amperes, and the appliance therefore can be plugged into an ordinary household outlet without blowing fuses.
The largest markets Bennett felt couldn't help but respond to a sales appeal centered on size and safety were hotel/motels and college residences.
(1) Motels: About halfway down the old road between Boston and Providence is MicroFridge's original hospitality-industry research lab: the lobby of a Super 8 Motel. There, Bennett polled guests. Would they be willing to pay an extra $3 to have a MicroFridge unit in their room? Yes, a startling 79% replied -- particularly since this place is in the middle of nowhere.
"Our segment of the lodging market is the economy and limited-service part, not executive suites," concluded Bennett. In budget facilities, restaurants (if any) close early, and late checkers-in can get little to eat beyond a bag of nacho chips. Put a MicroFridge in, charge a few dollars extra, and the unit's paid for in three months. Ninety nights @ $3 = $270, and the hundred dollars or so more comes from the front desk, which vends popcorn and other microwave foods at high margin to captive guests. Given a room's full occupancy, a motel can make more than $1,000 in its first year per installed unit. That's 300% ROI -- and the useful life of the humble appliance is presumed to be a good seven years.
In 1989 there were some 1 million rooms in establishments with limited or no restaurant service, and, trade sources estimated, that sector was growing at close to 10% per year. Bennett expects to put a MicroFridge in 2% of those rooms in 1990, yielding sales of nearly $7 million. By 1993, he predicts, he'll sell his units into 5% of the expanding market, for revenues of about $21 million.
(2) College residences. Fire statistics make for scary stories -- and easy selling. The National Fire Protection Association reports that an average 1,600 fires per year broke out in school, college, and university dormitories from 1983 to 1987; a MicroFridge-commissioned poll claims that some 90% of students use hot plates, although most universities forbid them. "They're going to cook anyway," Bennett reminds purchasing agents, "and our unit has no exposed heating element."
Besides, don't administrators want to attract paying customers? Parents don't have big families anymore, Bennett argues, so there's money behind the fewer children they do have. "Our push is for the school to put one in every room, which makes sense for the school. With their buying power, they can own the units inexpensively and rent them out." The school controls heavy-wattage appliance usage and reduces its liability exposure, and savvy administrators can enhance income in the process, stocking cookables in school-owned convenience stores and vending machines.
Based on its own market survey (substantiated by a test mailing to students at California's Whittier College, which resulted in a combined purchase and rental response rate of 12%), MicroFridge projects these campus revenues: $6.3 million in 1990, based on supplying 4% of the students at the 250 schools the company expects to reach, and almost $40 million in 1993, the result of supplying 7% of the students at 960 schools.
Those aspirations may seem giddy, but Bennett reminds doubters that "MicroFridges already are spreading across the country. If your school doesn't have them, your students won't be enjoying the quality of life they can get somewhere else." And, it's implied, they may choose to go somewhere else.
Microfridge Inc. was incorporated in August 1987, capitalized with $35,000 from Bennett, then age 31 and regional sales manager for a $44-million computer company. An additional $25,000 came cumulatively from two soon-to-be-active partners: Procopio Soriano, then 45, vice-president of sales at the computer company that employed Bennett; and Edward J. Ward, then 35, an M.B.A. who was manager of the engineering staff of a research firm. Bennett became MicroFridge's president and CEO, Soriano its VP of sales, and Ward VP of operations. None of the first-round capital was spent on management salaries: even with the alluring projections their studies endorsed, no principal rushed to quit his full-time job. First they had to make sure they could deliver the little device at an appropriately little price.
Novices at hard bargaining for hard goods, the partners arranged to travel in pairs as they searched for the right supplier, lest one tyro alone be tempted to give away too much. They contacted General Electric, Amana Refrigeration, and other domestic manufacturers but could stir no interest. So they tried Samsung Electronics and similar offshorers, and "within five minutes," Bennett recalls, "we were talking to someone in charge." Eventually, Sanyo E & E Corp., in San Diego, the U.S. affiliate of Japan's giant Sanyo Electric, agreed to produce the unit. In March '88 Bennett began negotiating terms. "They have 70% of the compact refrigerator business in this country," says Bennett in affirmation of the ultimate relationship with Sanyo. "They're a recognized leader, and that helps us, because who the heck is MicroFridge Inc.?"
MicroFridge would pay $170,000 for special tooling and molds, and put up $100 for each unit in advance of manufacture, which would take about four months from order to delivery. Units would be landed FOB San Diego, 3,000 miles from MicroFridge's corporate home in Sharon, Mass., in two parts, which would be drop-shipped across the country. When they got to their destination, the purchaser was to hitch them together with eight screws.
Neither those screws nor any other part of the 87-pound, 43 ½ inch-high unit is fabricated in the United States. The microwave component is assembled in Singapore and the refrigerator-cum-freezer in Tijuana. Manufacturing-wise, all that the 7 employees (including management) who constitute the entire pay structure of MicroFridge can do is admire the cost-effectiveness of cheap labor. (Hourly pay in Tijuana starts at about 80¢.) According to plan, at the end of 1991, MicroFridge will be employing 15 people at most, yet will have shipped some $30 million worth of the unit. "That's the beauty of subcontracting," Bennett beams.
MicroFridge was paying $270 for each unit at the end of 1989. But the five-year contract grants Sanyo the right to readjust the price in response to changes in costs of labor, currency, and material. The exposure doesn't worry Bennett. "If the yen-to-dollar goes in the wrong direction, we can get penalized," he admits, "but this business is competitive and has a history of stable pricing. And ours isn't so difficult a product that they can't keep moving it into countries with better labor costs." In March 1989 an exclusive agreement was signed. Sanyo cannot sell it to anyone else in the world.
"For someone to knock us off now," Bennett claims, "not only would they have to provide the circuitry, they'd have to build a separate freezer box from scratch like the one Sanyo already has." Therefore, he calculates, MicroFridge will be unopposed in the marketplace for perhaps two years, maybe longer. "If we turn ourselves into a $35-million-a-year company, someone will go after us," he grants. But by then, MicroFridge will have cemented a brand-name advantage.
The initial price the partners established for direct sales was $369, and when a dude ranch owner in Wyoming sent in cold cash after having seen notice of the machine in a trade magazine, they exulted, "This product is a no-brainer!" But, admits a now-wiser Bennett, "We definitely mispriced it early." And often. Shortly thereafter, retail was raised to $389, and a few weeks later, in September, to gain more operating margin it was boosted to $429. A yet higher price -- $499 -- was being tested at year's end. "Sooner or later we'll hit a ceiling," he pledges. "But we don't know where that is."
Then there was the question of how to move the merchandise, whatever the price. The choice was between big-margin, highly profitable sales on a direct basis without large volume, and selling at lower margins to distributors, making less money but getting the volume. Bennett opted for the latter, rather than face the costly prospect of building his own direct sales force, credit department, and warehousing and service operations. "We don't want to carry inventories, and we don't want to carry inns in Vermont," he ruled. Nor did he want his own people having to be the ones going around handing out $10 discounts for units that arrived dinged or dented. Let the distributors contend with that. Net profit would be lower, but, if revenue climbed, in the end who would care? "When you're positioning a company for a public offering or a buyout," Bennett argues, "revenue is the significant number."
Also among the presumed benefits of tying into distributors (whom MicroFridge charges from $309 to $323 per unit, depending on how many they order) is the rapid cash flow their prompt payment throws off. Appliance distributors make profits on rapid inventory turns and getting the money in fast, and then take advantage of manufacturers' discounts. "One percent net 10 tempts them," Bennett learned, "but 2% net 10 is guaranteed." The lowest credit rating of any distributor MicroFridge has considered is AAA-2 -- reliable payment within 30 days. Eventually, the plan goes, MicroFridge receivables will consist only of those from its distributors.
Bennett intends to blanket the map with distributors, to whom he will hand over existing house accounts. As of the end of '89, the company had signed up seven independent distributors -- in New England, the mid-Atlantic, the West Coast, Ohio, Michigan, and Florida, plus one who deals with the military. Accounts elsewhere will stay on a direct basis for the time being.
Where a distributor is in place, MicroFridge passes on qualified leads generated by one full-time, in-house telemarketer. "That's another thing you get with a distributor: follow-up," the salesman in Bennett savors. In turn, distributors "love" the affiliation, he claims, because the appliance opens discrete markets they've never had before, such as schools, hotels, and office-food services. And in making end-user sales rather than selling to a dealer, distributors enjoy from three to five points more margin than the 15% they customarily work with.
For its part, the company backs up distributors' sales with joint marketing. After contracting with its first major distributor last July, $50-million, 18-salesperson Choquette & Co., in Seekonk, Mass., MicroFridge got it moving by designing a mailing piece that was sent to 4,000 hotels in New England. The response was so positive that in August, for the first time, the by-then-full-time partners began paying themselves salaries.
Last June Microfridge raised $100,000 through a private placement of equity, at that time bringing the company's capital base to $221,000 (including a loan from the founders of $61,000). But it could hardly be called a base, since the sum had already been spent on start-up activities, some $50,000 going to legal fees, $6,000 to the market study, and much of the rest to appearances at national trade shows. How, then, to pay Sanyo its $100-per-unit down payment, never mind the $170,000 for tooling?
The latter could wait a bit; the former couldn't: by July, MicroFridge had booked orders for 2,400 units. A Korean trading company offered to finance them, and Bennett signed on for $170,000 credit at 2% of the amount financed plus an annualized 3/8 of a point over prime. MicroFridge's first order went to Sanyo for 1,700 units. The rest was backlogged. When the Korean company "tried to get higher rates out of us," Bennett reports, "we dumped them." For its second order, MicroFridge switched to Transamerica Commercial Finance Corp. at 1% plus 4 points over prime. "It may seem expensive, but it's very short money -- only days at a time." And Sanyo agrees. With the less burdensome terms, Sanyo rescinded its $100-in-advance demand. A third equity placement completed last November for $350,000 ought to relieve the rest of the credit crunch.
Raising private money -- most from relatives and friends -- has been comparatively uncomplicated. "The concept is easy to grasp -- after all, it's not gene-splicing," explains Bennett. Initially, however, the partners hoped to get funding from venture capital firms. "They wanted at least half," Bennett complains, "and were prepared to wait us out until we were absolutely desperate. So we said forget it, we'll operate on a shoestring." On purpose or not, the strategy continues to bring in just enough capital to take the business to the next stage. Even after last fall's sale of $15-a-share equity, the three original owners still owned 70% of the company -- at an investment of 56¢ a share.
That round at last made MicroFridge bankable, confirms consultant Peter A. Chapman, 55, a small-business specialist whom the principals brought in as treasurer and part-time CFO last April. Even though MicroFridge still owed Sanyo $170,000 for the tools, the company probably achieved the positive net worth status that commercial banks require. Soon, some loan officer should be willing to extend conventional debt financing for round four. When that happens -- maybe late this year -- MicroFridge will be off the inventory-financing factor's costly hook.
Until then, a current $1-million credit ceiling will impede MicroFridge's ability to satisfy distributors' demands for product. For example, the line will nearly have been used up paying for 1990's first two shipments -- 1,700 units due to arrive this month and 3,400 to arrive in March. When the company opted to forgo warehousing in favor of frequent production runs, it had to learn to live with Sanyo's four-month lead time. Forecasting had better be accurate, because coming into 1990, operating expenses were running close to $50,000 a month. Bennett projects that 40,000 units will be sold in 1990, and demand beyond that may have to be placed in backlog. If demand gets too brisk, distributors probably will be put on allocation -- a resolution they're apt not to like.
Clearly, Transamerica's financing can carry Micro-Fridge just so far. It must move ahead cautiously, since every new distributor likely will want a few container-loads (at 220 MicroFridges each) to start with, and putting them on hold won't do, thanks to the expense-free power of the press. "At first we were having a hard time finding distributors," Bennett relates. "But publicity has created a condition where distributors are calling us."
In just one week late in '89, a Boston-based 35-outlet office-supply chain purchased 220 units from Choquette and committed to 220 more, and the University of Massachusetts another 232. The torrent caused Bennett to conclude that New England, which he estimates is about 8% of the national market, was starting to gel. That left 92% of the country yet to come on with equally strong demand. It also caused Choquette president Normand Choquette concern, lest MicroFridge not be able to keep the product flowing. "And I don't know what the cure for that is," he grants, "because we sure can't inventory it that deeply." On the other hand, Choquette isn't about to drop the hot line: "We only need to deliver 2,500," says Choquette, "and we go over $1 million in billings."
Another budgetary concern is that MicroFridge -- not Sanyo -- must stand behind each unit. This it does nationwide through an autonomous appliance fixer, Sanyo Fisher Service Corp., which bills MicroFridge each month. MicroFridge's pro formas show conservative allowances for the service contract, but, says Bennett, "we're no longer getting that failure rate. We did for the first few hundred, and we said, hey, send them all back, we'll give you new ones." Now, co-founder Ward travels to manufacturing sites to monitor quality. But in case something slips by, on the back of each unit is a sticker with an 800 number that leads directly into Bennett's office. "It may be made by Sanyo," says Bennett, "but it's the MicroFridge name that's on the line."
Because they aren't actual manufacturers, Bennett prefers to conceive of his enterprise as a "research-and-development and marketing company." Indeed, already similar other would-be geniuses are dropping by with ideas. Among them: a portable microwave that dries clothes in 15 minutes and can also be used for cooking. The aspirants show up with their prototypes and patents, but Bennett has to turn them down. "Right now we have our hands full," he tells them.
Indeed, they do -- with more piling up. To broaden its sales base and cut off competitive inroads, Chapman would go international, taking advantage of secure patents in Japan and other key countries. Already, MicroFridge has been contacted by a housing authority in Saudi Arabia, inquiring into a possible 40,000-unit deal. And several Canadian distributors have also evinced interest.
If no ambitious entrepreneur (or GE, for that matter) rips off the product, perhaps someday the MicroFridge name will become a household word. Before then, the company has to pass its breakeven point, estimated to be 15,000 units, and settle into positive cash flow. And that prospect appeared achievable in the not-too-distant future. As of last December the government had granted preliminary approval of the unit's specs for the military, and more than 30 colleges across the country had put in significant orders, as had Econo Lodges of America, Super 8 Motels, and Howard Johnson Hotels & Lodges among motel chains.
Bennett is convinced that in Sanyo he has found the world's lowest-cost subcontractor. What with its shoestring financing and disdain of warehousing, MicroFridge's major hurdle remains securing adequate capital to keep the flow of cooler/heaters coming from abroad in timely fashion. One big distributor out of inventory is apt to force one little marketer out of business.
For an update on this company, see Anatomy of a Start-Up Revisited: Chillin' Out
MicroFridge Inc., Sharon, Mass.
Concept: Make a miniaturized combination refrigerator-freezer-microwave with a proprietary device that enables it to run off one plug in an ordinary household outlet, and market it for use in college dorms and budget motels
Projections: Pretax profits of $1.5 million on sales of $15 million in 1990, the first full selling year; sales of $30 million in 1991
Hurdles: Securing enough capital to keep product flowing steadily from manufacturing subcontractor to wholesale distributor; establishing solid market position before competitors -- big or small -- enter the niche
Robert P. Bennett, president and CEO
Family status: Married, one child
College degrees: Bachelor of applied mathematics, University of Maine; master of engineering management, Northeastern University
Typical workweek: 50 hours
Equity held: 40%
Outside board of directors: Not yet
Businesses previously founded: None
Last job held: Regional sales manager at small computer company
Most interesting characteristic of ownership: Can't stop thinking about it. Perturbs wife, because difficult to have conversation that doesn't relate to MicroFridge
What used to be concern: Running out of money
Present concern: Getting sales numbers up
Why line of business chosen: Sought a product, any product, to leverage sales abilities with; could just as well have been shoes
MicroFridge Inc. Projected Operating Statement ($ thousands)
($ thousands) 1990 1991
NET SALES $15,033 $29,695
Cost of sales 12,428 25,286
Gross profit 2,605 4,409
Percent gross profit 17% 15%
Salaries, wages, & benefits 459 914
Advertising, direct mail, & trade shows 75 115
Travel & entertainment 88 124
Professional services 55 66
Depreciation and amortization 62 106
Building occupancy, office 84 108
expenses, & misc.
TOTAL OPERATING EXPENSES 823 1,433
Interest expense 292 130
NET INCOME BEFORE TAXES 1,490 2,846
Percent net income before taxes 10% 10%
WHAT THE EXPERTS SAY
G. BICKLEY STEVENS II
General partner, Eastech Management Co., Boston, a venture capital firm that chose not to fund MicroFridge Inc.
The reasons we declined are that it was quite different from the high-tech venture deals that we ordinarily look at; plus, it had an inexperienced management team.
The positives were the patentable product and the exclusive tie-in with Sanyo, which to me were very powerful. The product was complete, there was a large potential market, and there could be high profits if sufficient units could be sold. I was intrigued and believed they'd end up selling over 50,000 per year. I admit there was limited evidence to support that case, other than my own reference checks and the results of Bennett's market study -- which, frankly, was quite limited.
On the negative side was an entrepreneur who didn't have much experience. He was bright and I liked him a lot, but the whole team had little knowledge of the marketplace. And it was essentially a distributor business with inherently low margins and relatively high cash-flow risks. It would have required a fair amount of hand-holding if we got involved.
Because of their inexperience, it makes a lot of sense to use only distributors and not keep house accounts. Any time you have house accounts, you create problems with your distributors. Right now, Bennett has enough other risks that he shouldn't yet risk his distribution channels.
Competition is a concern; definitely, he will have some. But I think Bennett's right -- he has a near-term advantage. If he can control his growth, he may be able to pull it off. Bringing in a CFO as they did was very, very important.
National product marketing manager, Samsung Electronics America Inc., Saddle Brook, N.J. The $15-billion Samsung Electric sells microwave ovens and compact refrigerators into domestic, college, and hotel/motel markets
Bennett's two markets aren't as broad as he thinks, but there's no doubt this product should be very successful within them.
However, he's presented a very aggressive picture and maybe hasn't been careful enough in considering things outside his control that will influence his company's performance. For example, while it's true that MicroFridge could be attractive to his targeted motel chains, which are trying to differentiate themselves, it's an area of the industry that's based on being no-frills. Yet for the MicroFridge-in-your-room deal to work for guests, these motels will have to provide things to cook or cool. Will a no-frills hotel want to keep food in stock? And who's going to service that food supply? How is Bennett going to make sure hotels are hooked up to food distributors?
I'm not an engineer, and Bennett apparently has the patents for the current-switching device, but I don't believe it would be that difficult to build something similar without copying. A major appliance maker could come up with its own product in six months. If a brand-name company like GE decides to get into the business, it will most definitely affect his five-year plan. People feel more comfortable with a name they know. The GE name on the same product, even if it's more expensive, would sell. I'd guess that big-company interest will depend a lot on MicroFridge's success. Bennett's probably got a two-year lead on his competitors, which gives him somewhat of an advantage. But no matter how big he builds the MicroFridge name in those two years, a GE name or an Amana name is bigger than he'll ever get.
Vice-president of purchasing, Days Inn of America Inc., Atlanta, operator of 950 economy-class motels throughout the United States
The MicroFridge people identified a big market -- college kids. Motels will also pick up on it, especially the suite properties. I'm willing to look at it, and I think most destination and commercial properties will have an interest in this type of product. The switch is the key to the whole thing. You could buy the appliances separately, but MicroFridge has only one cord. You don't have to have the three pieces spread across the room. You can have them in one location.
We also have a lot of motels along highways, and once people -- especially older people -- get into their rooms, they want to stay in their rooms. They don't like to go out, because they don't know the area. If you have microwave food and equipment available, you're going to increase the value of your accommodations, and most people won't have a problem with paying $3 more.
Business manager, housing division, University of Michigan at Ann Arbor
MicroFridge would have a problem here, because we still have a policy that microwaves are not permitted in the students' rooms. Cooking in the students' rooms is prohibited; it's one of those fire safety issues that's been around for many years.
But Bennett may have a good argument that a microwave can allow you some safe cooking in a student's room. We're interested in student services, so if in fact we can do it safely and students want it, then we'll be discussing it more in the next year or two. Still, we have not seen a group of students saying they want to have microwaves in their rooms. And that usually has to happen before we consider doing something like this. These days we're encouraging students to have computers, which is probably one of the reasons we'll stick tough with the microwaves for a while. If you had a microwave and a refrigerator and two computers and a hair dryer all in the same room, we'd have some concerns.
If we did bring in units like this, I'd be worried about buying from a new company. You've got a refrigerator and a microwave that's totally redesigned. Bennett says the product life should be seven years, but this power switch has never been done before. Will that microwave last seven years or will it last three years? And if the microwave goes bad, what do you do with the refrigerator? This is a new concept, and there's more risk involved in buying something that you haven't seen on the market.