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MARKETING

Sound Strategy

Profile of a start-up company founder's attempts to sell stereo speakers directly to the consumer.
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In an industry that reaches customers through dealers, lone operator Dave Fokos thinks he can sell his high-end Icon stereo speakers direct to the people who'll use them

* * *

The building, low and modern, sits back in the woods off a road that winds through an industrial park. The parking lot is empty save for a car or two under a dank winter sky and the looming skeletal shapes of trees. Inside, the feeling is one of equal desolation. A room bathed in shadows gives way to a nearly silent manufacturing area and warehouse. As a young man of medium height, dressed in jeans and a hooded sweatshirt, assembles a cardboard shipping carton, the sound of a ringing phone drifts from the front of the building. He drops what he is doing and sprints for the phone. "Hello, Icon Acoustics. . ."

Four years ago, when Dave Fokos was dreaming about starting a company that would make loudspeakers for the high end of the stereo market, he would run the numbers -- in longhand -- through various iterations to reveal the cash flowing fast and steady, the phone ringing off the hook with customers eager for his product. Fokos even drafted a statement that read like a manifesto proclaiming the rise of a postmodern workers' paradise under Icon's roof. He planned to have a company that afforded a quality work environment and subsidized education for its employees; a company that opened its books to all workers. He figured that by 1991 he'd have a staff of three or four people happily assembling speakers under the gentle glow of halogen lights, pausing during their herbal-tea breaks for a leisurely perusal of Icon's books, and after work, heading out to a company-subsidized concert.

But it hasn't quite worked out that way. Icon Acoustics Inc., based in Billerica, Mass., is for now one guy alone in a building out in the woods.

* * *

The Idea Dave Fokos is just 30 years old. He exudes the certainty of a craftsman who long ago found his calling. He has been fooling with audio equipment since his high school days. At Cornell he majored in electrical engineering, taking whatever electives and independent-study courses he could to further his skills as an audio engineer. (One of his former professors is an Icon investor.) By graduation, Fokos had designed and built a commercially viable pair of loudspeakers.

In June 1984 Fokos, fresh out of college, landed a job as a loudspeaker designer for Conrad-Johnson, a high-end audio-equipment maker in Fairfax, Va. In the next four years Fokos would be the principal designer of 13 speaker models for C-J, an experience he calls "an invaluable apprenticeship" for running his own show. Fokos founded Icon Acoustics in April 1989, believing the niche he sought had scarcely been explored.

Most stereo equipment is sold through dealers. But to small and craftsmanlike speaker builders like Dave Fokos, many audio dealers are a retrograde lot, grinding manufacturers' margins down to the nub and selling not what they believe in but whatever happens to be piling up in the back room this month. They sell a relative handful of popular, mass-produced models, effectively denying more customized offerings access to the mainstream market. What Fokos wanted to do with Icon was to bypass what he saw as a dealer cartel.

Icon seeks to sell direct from the factory. Customers can call Icon on an 800 number and order speakers. Icon pays for shipping and any return freight via Federal Express, and customers can try out the speakers at home without obligation for 30 days. If questions or problems arise, Fokos is available, via his 800 number, to give advice.

Fokos sees several advantages for his customers. Not only is the dealer markup -- 100% or so -- avoided, but with the home trial, buyers can listen to the product in their actual environment before making a decision. Most important, direct selling makes available to the listener a niche product that would not be profitable for most dealers.

Icon's product line consists of two models. Its Lumen speaker stands 18 inches high and weighs 26 pounds. A pair currently sells for $795. The Parsec, 47 inches high and 86 pounds, sells for $1,795 a pair.

Both models have components of very high quality that in many cases cost 10 times what the equivalent part in a mass-produced speaker does. In that way, they embody the Icon ethos: cram the speakers with quality components and craftsmanship -- and then sell them for half the price a dealer would charge.

* * *

The Market Fokos defines his target market as people who love to listen to music, equipment junkies, the audio-addicted. They tend to be educated, affluent, and obsessed. As Fokos puts it, "These people would rather buy a new set of speakers than eat."

But reaching enough of those people is Icon's challenge. Consider this: There are about 335 stereo-speaker makers in the United States selling to a $3-billion-a-year market (for all audio components). About 100 of them sell to the low end and midrange of the market -- say up to $500 per pair of speakers -- which accounts for about 90% of that $3 billion. That leaves roughly 235 specialty companies fighting over a market that amounts to no more than $300 million.

"It's a tough go for many of these companies," says John Atkinson, editor of Stereophile, a monthly consumer magazine. "They are forced into an area where they are trying to compete with the Japanese," he says. "Japanese products sold in the United States are of relatively poor quality but are sold at an affordable price." The U.S. products are often expensive, but they are often very good.

Most of those 250 companies are undercapitalized and therefore unknown. Plowing most of their resources into building speakers, they have little left over to market them with. That, too, was Icon's problem. How would Fokos get the word out?

* * *

The Marketing Strategy The first thing Fokos wanted to do was to create an identity for his product. He strove for a look, an attitude. "At this end of the market people buy speakers for a lot of irrational reasons," he says. Buyers may want good sound, but at these prices they are also in search of an aesthetic. Icon's speakers have a sleek, potent look. On the back, a laminated label, carefully hand-lettered just above the gold-plated input jacks, reads: "This loudspeaker was handcrafted by Dave Fokos. Made in the United States of America by Icon Acoustics, Inc., Billerica, Mass."

Fokos interviewed seven graphic-design firms before he deemed one worthy of giving Icon a corporate identity. He then spent $40,000 on stationery, business cards, a brochure, and the production of one display ad, all of which are distinctive in their design and feel. Fokos makes no apology for that outlay. He considers the expense a good long-term investment.

From the start Fokos planned to spend little on display advertising. He considered it expensive and not cost-effective. He would pursue a more grass-roots approach. He had contacts in the industry. He figured he could get his speakers reviewed in consumer magazines. He thought he could get feature articles written about Icon. He would go to trade shows where the cognoscenti congregated. He had his fancy brochure to send around, and in the trades he would take out cheaper classified ads, whose print, no matter how fine, would be scoured by the true believers.

* * *

The Financing The generally positive reviews Fokos had received for his speaker designs at Conrad-Johnson enabled him to raise some money to start Icon. At C-J he had acquired a following among some hard-core customers, and several of them became Icon investors.

Fokos wanted Icon to be debt-free. He decided upon a private stock offering, and by early 1989 he had sold 42% of the company for $189,000, or $4,500 per 1% share. That would be his working capital. (He kept 58%.)

In Icon's third year, Fokos figured, the company would pay its first dividend -- 30% of the original investment to each original shareholder. In year four the number would jump to 70%, then to 100% in year five.

Those numbers were based on his initial revenue projections, which started in 1990 at $225,000 (300 pairs of speakers sold) and doubled each year for the next three, reaching $1.8 million by the end of 1993. Fokos estimated sales at $2.5 million in year five, 1994.

He originally projected that Icon would break even in 1990, with about two-thirds of revenue covering inventory, equipment, and marketing. The balance would be for general and administrative expenses, which included Fokos's salary of $24,000. In 1991 and 1992, he projected, pretax net profit margins would rise to about 12% and 23%, respectively.

But by early 1990, with most of his money plowed into inventory and equipment, Fokos had to abandon his debt-free strategy and seek a $50,000 loan -- a loan he would not be able to secure until midyear. "That money was spent before I had it," he recalls.

* * *

Operations Dave Fokos can build and ship two pairs of small speakers or one pair of big speakers per day. At that pace, he figured, he could run the company solo for a year. Labor was not the issue. It accounts for only 14% of the total cost of Icon's speakers. The big bite -- 86% of the cost -- comes from buying all those fancy components. Icon needed a lot of capital ($100,000) on the front end to plow into inventory.

Icon Acoustics began life on April 1, 1989, and quickly ran into trouble when Fokos couldn't immediately get his hands on that money. He needed regulatory approval for his private stock offering in the states in which his investors lived. Fokos had hired a lawyer who told him that was no problem; the paperwork would take three weeks. It took three months. It wasn't until August that Fokos had access to his working capital.

Without that, he had to dig into his own $10,000 stake in Icon to pay the rent starting on May 1. Fokos had figured he would build his prototypes in the spring and early summer and have production speakers for sale by October. Now he knew he'd be lucky if he had the prototypes done by the first of the year.

In January 1990 Fokos ordered 10 sample cabinets. He knew from experience that finding a reliable cabinet supplier that could meet his demand would be key. He had wanted to use a cabinetmaker in Colorado who did high-quality work, but the distance and shipping cost proved to be a hurdle. Fokos chose a source much closer to home, in Medford, Mass. The cabinets took two months to arrive, but they looked good. What Fokos didn't know is that it would be downhill from there. Subsequent quality fell off, sending him on a time-consuming search for a new supplier. Even though the sample of his big speaker, the Parsec, drew a favorable response -- and 54 orders -- at the High End Hi-Fi Show in New York City in April, Fokos was unable to realize much of that business. It would be at least two months until he even had any production cabinets.

Still, by June Icon was beginning to look like a real company. Its hit-or-miss marketing strategy, relying on magazine reviews and word of mouth, was starting to hit. In a report on the High End Hi-Fi Show in its August 1990 issue, Stereophile magazine said this about Icon's speakers: "The overall sound was robust and dynamic, with a particularly potent low end. Parts and construction quality appeared to be first-rate. Definitely a company to watch."

In an accompanying vote dubbed "The Best Sound at the Show," with ballots cast by attendees, rating 200 brands, Icon's Parsec speakers, selling for $1,495, placed 15th. In the top 10 the least expensive were $2,400 a pair, and six of the systems sold at prices ranging from $8,000 to $18,000.

Fokos sold 20 pairs of speakers in October and another 20 in November. He also invested in one slickly produced four-color display ad, featuring the Parsecs, in the buyer's guide issued in October by Stereo Review, the consumer magazine with the largest circulation (506,000). That dovetailed with a generally favorable review in December in Stereophile magazine. For the last six months of 1990, the company's sales registered $70,000.

But just when Icon started to roll, it hit more snags. It was running low on a key component, woofers for the Parsecs, because of a mix-up with the German manufacturer. Then Fokos's bank failed, denying Icon's customers the ability to charge their orders on credit cards. In mid-January war broke out, and Icon's phone fell silent.

In February Icon started getting speaker cabinets from a new source Fokos had met at the stereo show in New York the previous April. The quality was higher, but so was the price. The cost of cabinets for the large speakers rose from $90 to $150; cabinets for the small ones increased from $45 to $55. The price of his elusive German woofers, now reordered, jumped 36%. Product returns -- 19% for the last six months of 1990 -- were greater than Fokos had allowed for. (Shipping a pair of Parsecs round-trip costs $486.) Those factors put pressure on Icon's margins.

Fokos all along had wanted to achieve a gross profit margin of 50% -- to sell a pair of speakers for twice his cost. But that target was always too ambitious. It conflicted with a key marketing aim, to hit certain price points Fokos had deemed attractive ($695 for the Lumens and $1,495 for the Parsecs). By early 1991 Icon's gross profit margin had dwindled to 25% and 29% for the big and small speakers, respectively.

Fokos knew he had no choice but to raise his prices, an action he fretted over. "People will assume I'm shafting them," he says. "But these speakers are still a good deal at the new prices." On February 1 of this year the price of the Lumens went up to $795 a pair. On March 1 the Parsecs went up to $1,795. That raised the gross margin on each to 37% and 38% respectively -- still well short of 50%.

And yet the higher prices didn't seem to put people off. In February the phone started to ring steadily. Fokos was getting about five queries a day. One out of seven callers bought speakers. People had seen his handful of ads. They had heard of the speakers by word of mouth. Icon had more magazine reviews to look forward to in late spring, including one in Stereo Review. Stereophile was going to put the Parsec on its Buyer's Guide list of recommended components. Maybe now there was hope. Maybe Icon's best days lay ahead.

With things perking up, Fokos plans to introduce two new speakers -- the Micron ($1,395 per pair) and the Millennium ($5,695 per pair) -- in October to coincide with a large trade show in Santa Monica, Calif. Extrapolating from past performance, seasonal swings in the business, and the prospect of increased exposure, Fokos revised his projections. (See "Financials," page 4) He now believes 1991 will be his first break-even year.

* * *

The Hurdles Doubts and questions dog any start-up, but with Icon Acoustics they abound. Can Dave Fokos really count on word of mouth and favorable reviews to generate critical mass? If he needs to advertise and pay his debts, will he lose controlling interest in Icon in exchange for a capital infusion? And what about his investors, with visions of 70% dividends clearly on hold? At what point will they get antsy?

On the other hand, if Icon takes off, will Fokos, so dependent on inconsistent suppliers in the past, be able to manage the surge? Will he get squeezed again on costs and see his margins erode once more?

Dave Fokos acknowledges those doubts but confronts them without flinching. He is sure there is a big market of economy-minded audiophiles who will see the value of his speakers as more favorable reviews start to come in. Yes, he has thought about selling more stock to an angel to get out of debt and pay for some advertising. He doesn't see that strategy changing the dynamics of Icon. He considers his current suppliers reliable. He labels his investors "concerned but optimistic."

But for now Icon's is still a tale written in red ink. Fokos recites his litany of financial woes: "Last year I paid myself $9,500 in salary; the year before that it was $8,300 for nine months. The company has $50,000 in bank debt and $30,000 in bills that need to be paid. My interest on the bank debt alone is $500 a month." He draws an audible breath, considering the weight of it all. "This is certainly the toughest thing I've ever done," he says. "It has influenced my health a little. I can feel the stress inside. At times I ask myself, Is it worth it?" He pauses, then smiles. "But that doesn't last very long."


EXECUTIVE SUMMARY

The Company: Icon Acoustics Inc., Billerica, Mass.

Concept: Sell high-end stereo loudspeakers direct from the factory, with a 30-day free trial period. Icon thus avoids dealer markup, achieves national distribution, and offers a high-quality product at a reasonable price.

Projections: Revenues of $303,000 in 1991, rising to $1.3 million in 1993, with pretax profit rising from $1,746 to $302,000, respectively.

Hurdles: Financing a marketing effort to achieve name recognition in a crowded and highly fragmented market.

THE FOUNDER

David Fokos

Age: 30

Family: Single

Source of Idea: Worked as a speaker designer for a major manufacturer. Needed the freedom to implement his own ideas. Saw deficiencies in the relationship between high-end manufacturers and dealers.

Personal funds invested: $10,000

Equity held: 58%

Salary: $12,000

Workweek: 50 hours

Education: B.S. in electrical engineering, Cornell University

Other companies started: None

Last job held: Loudspeaker designer, Conrad-Johnson, a manufacturer of high-end audio equipment in Fairfax, Va.


FINANCIALS

Icon Acoustics Inc. Projected Operating Statement

($ in thousands) 1991 1992 1993 1994 1995

Pairs of 224 435 802 1,256 1,830

Speakers Sold

Total Sales $303 $654 $1,299 $2,153 $3,338

Cost of Sales

Materials and $130 $281 $561 $931 $1,445

packaging

Shipping $43 $83 $157 $226 $322

Total $173 $364 $718 $1,157 $1,767

Gross Profit $130 $290 $581 $997 $1,571

Gross Margin 43% 44% 45% 46% 47%

Expenses 1991 1992 1993 1994 1995

New property and $3 $6 $12 $15 $18

equipment

Marketing $13 $66 $70 $109 $135

General and $51 $110 $197 $308 $378

administrative

Loan repayment $31 $31 -- -- --

Outstanding $30 -- -- -- --

payables

Total $128 $213 $279 $432 $531

Pretax Profit $2 $77 $302 $565 $1,040

Pretax Net Margin 1% 12% 23% 26% 31%


WHAT THE EXPERTS SAY

OBSERVER

JOHN ATKINSON

Editor of Stereophile, a consumer magazine for audiophiles in Santa Fe, N. Mex.

One function of dealers is that they become your first customers. They'll tell you right away if the product isn't selling and why. They become your beta test site, and by selling direct Fokos doesn't have that.

More important, if you look at all successful mail-order companies, they devote a large portion of their budget to promotion -- and have something like a major advertising program or a direct-mail catalog. You have to advertise continually before people will take you seriously. Fokos's promotional efforts, in contrast, are largely onetime events. The general wisdom in this industry is that product reviews are good as part of your overall promotion, but if they are your sole means of promotion, the risks are too high.

OBSERVER

ROBERT BLATTBERG

President of Blattberg Consultants, a Chicago-based marketing firm that does extensive work with direct marketing

Fokos is making a classic mistake that a lot of entrepreneurs make: he's underestimating what the distribution channel can do for him. There's a reason for the 100% markup dealers charge: They advertise. They provide an easy way for the customers to find the product. They deal with product returns. They service the product after the sale. They hold inventory. Those are all problems that Fokos himself now has to deal with.

And dealers offer a forum for customers to compare products. There's no way Fokos's potential customers can do that. I'm sympathetic to some of his points, namely that dealers sometimes set up unrealistic listening environments, push products that are better sellers or have higher margins, and so on. But he also has to realize that there's value there.

Can he continue to generate enough leads simply through reviews and word of mouth? He should think about more advertising and possibly direct mail. His advertising should create an image of him as a guru. That's what people are really buying: a special product designed by a special man in a special market.

COMPETITOR

FRANK REED

Chief executive of Boston Acoustics Inc., a loudspeaker manufacturer in Lynnfield, Mass. Reed formerly held prominent positions with two industry giants, Advent and KLH.

Fokos suggests that the quality of his product is demonstrated in the expensive components he uses. But the cost of his components doesn't really relate to the quality. It relates to his inefficient economies of scale.

He says the retail audio market is stifling, but it isn't as cutthroat as he contends. I don't believe any single manufacturer has 10% of the market. He says it saves a lot of money to sell direct. But I suspect his costs of sales -- advertising, freight costs -- will be as high as those the guy selling through dealers has. He says he didn't want to sell through dealers because it offers limited distribution. Why can't he have a small network of esoteric dealers and supplement that by selling direct wherever he doesn't have a retailer?

OBSERVER

KATIE MULDOON

President and CEO of The Muldoon Agency, a New York-based direct-marketing firm

There are two types of successful direct marketing: a onetime product that has high margins and is marketed with lots of space advertising, or a continuing business built on an entire product line, often sold through catalogs. Fokos's business is neither. He might be better off attempting to strike some sort of cooperative venture with an established catalog, like Sharper Image, a venture that would allow him to tell his story without bearing the whole cost. Credibility is essential if he's going to sell direct. And he doesn't have a famous name. A company like American Express might be able to make a direct-mail campaign work for him because it would be endorsing him.

FINANCIER

HENRY MORGAN

Partner, Innovative Capital Partners, in Waltham, Mass.

I agree with Fokos's assessment of dealers. I'm an investor in Cambridge Soundworks (another direct seller), and I've seen that audio retailers always want to push something new. So your product doesn't have a long life cycle. I agree that for Icon, selling direct is probably the right way to go.

But I think Fokos is overestimating the size of his market. His projections of about $3 million are high -- $1 million is more like it. He doesn't have the name recognition right now that would give his products clear superiority over some of the stuff people currently like to buy.

Also, I don't think this is a price-sensitive business, and I think he has to get at least 50% margins. Or else he can't support himself or afford to advertise effectively. He has to raise his price, and he must get his costs down. He's very fussy about how he buys components, but a lot of that quality he's striving for isn't going to be perceived by the customer.

Also, in direct marketing, customers want quick, reliable delivery time. Fokos has to have enough inventory to fill orders quickly. He has to eliminate some of the glitches he's already experienced with his suppliers.

Last updated: May 1, 1991




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