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Packing Them In

Analysis of an environmentally-friendly industrial packaging & gift-wrap start-up.
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Can Puff Pac Industries, touting an unproved but allegedly revolutionary product, break into an industry owned by giants?

It started by accident, on a summer evening in 1983. Dan Pharo was at his art studio, where he made designs for balloons, preparing to visit a friend's young son in the hospital. He had a toy truck for the boy and a balloon to go with it, one of those Mylar numbers with a get-well motif.

Fortunately, as it would happen, Pharo overinflated the balloon and the side blew out. As he repaired the seam with a heat sealer, he decided for the fun of it to put the truck inside the balloon -- it could be the gift wrap. So he inserted the toy, sealed the balloon back up, and reinflated it.

At the hospital Pharo's little invention, essentially a gift inside a gift, like a ship inside a bottle, was a big hit. The boy was so fascinated by the thing that he didn't want to open it. "The real thrill for him was the packaging," Pharo says. "Everybody was trying to guess what was in there."

The doctors and nurses, equally intrigued, started calling Pharo to see if they could get one, too. A friend with a stationery store looked at it and said he could sell an item like that. Then Pharo showed his creation to the management at M&D Balloons, a San Francisco company for which he was making designs. Patent it, they told him.

Pharo, then 32, had already proved to be an incorrigible entrepreneur. After dropping out of college, he started a company that made macramé beads out of dead cactus. In 1977 he launched Grapevine Tables, making exotic furniture out of old Napa Valley grapevines. He sold that in 1980 to open the art studio near Sacramento, Calif.

Still, Pharo says, all his life he had invented things and more or less given away the ideas. Not this time. "I decided I could make a real business out of this one," he recalls. He sold his sports car, his van, and his hot-air balloon to scrape together about $125,000 for his new venture. Family and friends contributed another $100,000. And in July 1986 Pharo set up shop in the Los Angeles area, calling his company Puff Pac Industries Inc.

By late 1988 he was ready to market the inflatable gift wrap, and for initial production he turned to M&D Balloons. An equity infusion of $150,000 from five limited partners helped finance Puff Pac's early going, and distributors sold the products to stores across the United States and Canada.

People loved it. Bearing a gift in a decorative Puff Pac pouch eliminated the need for boxes, wrapping paper, and ribbon. It was new and fun. Al Trotter, who at the time handled merchandising for a Canadian drugstore chain, brought the pouch into Canadian shopping malls that Christmas and did very well with it. "A kiosk selling Puff Pac gift wrap could do $25,000 a month," he recalls. Trotter liked the product so much, in fact, that in early 1989 he visited Pharo to request licensing rights for all of Canada.

It would prove to be a watershed meeting, for it was then that Pharo showed Trotter his latest innovation on the bag, the breakthrough that would turn Puff Pac from a fledgling novelty company into something far more promising.

Pharo had discovered a way of putting a bag inside a bag. More precisely, he had hit upon the idea of heat-sealing a polyethylene bag inside a Mylar bag. By means of an "air exchanger" he created a double-chambered Puff Pac.

What it could do, in essence, was suspend an object in midair. The item could be held snugly in place by air pressure inside the inner bag and cushioned on all sides by equal air pressure in the outer bag. "I realized immediately what I had," Pharo says. "This was a new way to package things."

Trotter saw the potential, too. The double-chambered bag could add value to the gift-wrap line. But more important, it represented a serious opportunity in industrial packaging. If successfully produced, it could replace such environmentally unfriendly packaging materials as bubble wrap, fabricated foams, and polystyrene peanuts.

Here, perhaps, was a solution to an urgent problem -- the fast-dwindling capacity of landfills. Packaging waste takes up 30% of landfill space by volume and 10% by weight, and the packaging industry is under attack for its prodigious leavings. By Pharo's reckoning, Puff Pac could reduce the amount of packaging trash by 90% or more, because once the bag is deflated, all that remains is a thin membrane of plastic film. And used bags didn't even have to be discarded. They could be recycled or, up to a point, reused.

All Pharo lacked was cash to move the product beyond the prototype stage. He had scoured the country for funding but had come up empty. Investors were concerned, he says, that a patent hadn't yet been awarded for the double-chambered device. But Trotter volunteered to take a shot at fund-raising and soon found backers in his native British Columbia.

Among them was a financier named Don Farrell. He was so impressed by Puff Pac's prospects that he invested $700,000. Then in November 1989, using a reverse merger, Farrell and his associates took the company public on the Vancouver Stock Exchange. It remained a U.S. corporation, but the move enabled Farrell, who assumed the role of Puff Pac's market maker, to raise some $3 million in private-equity placements.

* * *

Pharo knew he was ill-equipped to run the business himself. He was an inventor, an idea man. He would serve as chairman and product-development chief. But he needed the kind of people who could take his concept and run with it, people like Trotter, who quit his job in Canada in 1989 to head up Puff Pac's sales and marketing operations.

Recruiting talent was easy; the company's potential seemed obvious to everyone who studied it. One was engineer Henry Swartz, an expert on machinery for processing and packaging plastics. He had helped Dow Chemical develop the Ziploc bag in the 1970s. When he saw Pharo's double-chambered air-packaging device, he was astounded.

"I regarded it as one of the greatest advances in packaging since the introduction of bubble wrap, in 1960," Swartz says. "The big sales feature is that Puff Pac bags weigh very little and displace almost no area, so you can get more payload into a truck or freight car. And it's a very clean package with a huge edge on the environmental side."

Swartz, now 65, was on the verge of retiring until he saw Puff Pac. Instead, he became vice-president of technology, bringing with him 40 key patents in the field of heat-sealing plastic film, the technology at the heart of Puff Pac's potential.

For president and CEO, the company turned to Henry Saltiel, another Canadian. Saltiel had been a senior Xerox manager before starting a residential-construction company in British Columbia. He was still running that business successfully when a Puff Pac principal showed him a prototype of the double-chambered bag. Here was a product, Saltiel thought, that could make it big in the packaging world. Intrigued by the challenge, he came aboard.

* * *

Saltiel could envision the inflatable-gift-wrap side of the company becoming a $30-million business in five years. The bags came in three sizes, and just like regular Mylar balloons, they could carry designs for Christmas, Valentine's Day, Mother's Day, birthdays, and more.

The smallest of the trio, which could accept items up to 10 inches long -- a paperback, say -- could be produced for about 28¢, sold to distributors for 57¢, and retailed for $2.29. The largest bag, a 21-incher, would retail at $4.99. Al Trotter's marketing surveys found "zero price resistance," he says, at those levels. And across the board the bags offered Puff Pac gross margins of 40% or more.

But in the long term, the serious money was on the industrial side. Sales of so-called interior packaging materials, Puff Pac's prime market, are estimated at $2 billion a year in the United States, and more overseas. Interior materials are used by companies that ship products requiring cushioning protection during transport, everything from electronic devices and engine parts to glassware.

In the United States, this area of packaging is dominated by about a dozen big suppliers, including the likes of Dow Chemical and Sealed Air Corp., which invented and makes bubble wrap. Puff Pac represented a radical departure in the way shippers did business, and it would be going up against giants. But its unique advantage was its timing.

"Ten years ago I would have said that Puff Pac is a nice little oddity that would never go anywhere, because shippers wouldn't pay the price for it -- it might cost a little more," says industry consultant Alfred H. McKinlay, who spent 27 years as a packaging engineer with General Electric. "But the pressure to reduce packaging waste is so intense now that a lot of companies will definitely consider using Puff Pac."

In a formal market analysis, McKinlay estimated "conservatively" that Puff Pac industrial bags could achieve a sales volume of $200 million, provided the company manufactured quality products and marketed them intelligently. He saw opportunities for the company to make protective packaging for small electronic and mechanical devices, small instruments and other fragile items, and spare parts.

To Pharo and Trotter, however, the industrial possibilities seemed endless. They envisioned air-cushion bags for everything from wine bottles to sporting goods. With Henry Swartz's patented heat-sealing technologies, they were already crafting plans for bags up to 10 feet wide, and others of various shapes. One idea was a 12-sleeved bag for china dishes. "Movers would love it," Trotter says.

Addressing one industrial concern, Pharo was already tinkering with fluted and quilted bags -- the plastic-pouch equivalent of a double-hulled oil tanker. If one chamber was punctured, the others would still do the job.

By 1990 Puff Pac was operating from an industrial park in Valencia, 25 miles north of L.A. Demand for inflatable gift wrap was strong -- 1989 sales hit $1.6 million. But the company's challenges were only beginning.

Its strategy called for subcontracting the production work. The single-chambered gift wrap could be manufactured on any machine that made plastic bags. Lots of companies did that kind of work.

Mass production of a double-chambered bag, however, required a sophisticated, computerized fabricating unit, capable of moving sheets of film along a conveyer at precise speeds and controlling the temperatures of the heat-sealing units that melded the plastic together. A machine like that would cost about $500,000, and none existed.

Puff Pac didn't anticipate spending anything to gear up to manufacture. It wanted to husband its resources for product development, marketing, and patenting, while making the first double-chambered bags by hand. "We had made thousands of them like that, doing tests," Pharo says. "It's not as efficient, but we were prepared to make the first 500,000 or so by hand, until we sold enough to get the money to buy a machine."

Enter Mantae America Inc., a Korea-based company that was already supplying Puff Pac with single-chamber gift wrap. Mantae proposed to do all the double-chamber work -- it would buy two machines and handle all the manufacturing. Puff Pac accepted.

But things didn't go as planned, as things often don't. The machines, designed by Pharo and an engineering team, weren't delivered until November 1990, three months late. And then Mantae compounded matters by failing to meet its production promises. Unable to get enough bags on time, Puff Pac was forced to turn down Christmas orders totaling $1.5 million. It finished 1990 with sales of $543,000 and a net loss of $1.9 million.

It was a disaster. In fact, it might have been the end of Puff Pac had the Koreans not made an offer for 1991 that Puff Pac couldn't refuse. Mantae was willing to extend a $2-million line of credit, plus 90-day terms. The Koreans said they had worked out the production bugs and were ready to try again. "We had no choice but to accept," says chief financial officer Harry Mitchell about the Mantae offer. "It was the only way we could keep going."

So in January 1991 Puff Pac ordered 8 million bags from Mantae, betting the ranch once again on the Koreans. Trotter was sure he could move 8 million bags. The independent sales groups he was marketing through were geared to start selling the gift-wrap pouches to Wal-Mart, Woolworth's, Ekard Drug, and more than 3,000 other stores.

By midsummer, however, things were turning ugly with Mantae. Production was wildly behind schedule. Only 500,000 bags had been made, mostly by Puff Pac's own people working in Mantae's Walnut, Calif., factory on a Puff Pacbuilt fabrication machine that Mantae had yet to pay for.

On Labor Day a desperate Pharo took action. He and Mitchell rented a dump truck, drove to Walnut, packed up the machinery, and installed it in Puff Pac's warehouse in Valencia.

* * *

All last fall, Puff Pac scrambled to survive.

It was now in the manufacturing business, like it or not, and the transition was costly. Adding three shifts of labor to run the machine and handle ancillary work boosted biweekly payroll from $20,000 to $40,000.

At least now the company had some control over its destiny, but the damage was severe. Bags were being shipped as fast as they came off the machine, but several million bags promised to distributors simply could not be produced in time. "That's caused me a lot of problems," says Trotter. "The minute you don't deliver product, the sales reps don't even know your name."

But by dint of 18-hour days, an unshakable belief in itself, and almost miraculous luck, the company managed to pull back from the brink.

Money suddenly appeared to cover operating losses. Don Farrell in Vancouver was able to convert stock options and warrants to generate cash. In December a Swiss investment bank came through with a $1.5-million investment. And the sales that were made generated greater profits than expected. "We projected a gross margin for the gift wrap of about 42%," says Saltiel. "With the Koreans out of the picture, it is closer to 50% or 55%."

The company urgently needed another machine to service its contracts with Unique Industries, a major party-goods reseller located in Philadelphia, and the others. Amazingly, it found a small company in Rhode Island, Chase Machine Co., which agreed to take a 15% down payment in the form of Puff Pac stock.

Chase would build a brand-new machine, a second-generation model capable of producing 12 million bags a year. With technology chief Henry Swartz on the scene, Chase turned it out in three months.

And as 1991 was winding down, Saltiel was closing in on his first two licensing deals, one with a Dutch company and one with a German outfit, which would give them rights to manufacture and sell Puff Pac gift wrap and industrial bags in Europe. Combined, the licenses would be worth $3.8 million, on top of which Puff Pac would collect 6% royalties on gross sales.

The company, finally, seemed to be on its way. For 1992 it projects sales of $16.5 million, half in gift wrap, half in industrial bags, and with a swift ramp upward in the following years.

But all that hinges on Puff Pac's ability to clear remaining hurdles. "We need the ability to buy materials properly, cost-effectively, and at the right time," says Saltiel. "We need to get the quality that's required. And we need to decide how much of our finite capacity to devote to running industrial and how much to running retail. We get three stars for reacting quickly to an emergency. But I don't think we have in house the expertise to be able to plan a solid production process, and that's what we need."

But Pharo, despite all he's been through, remains as optimistic as the bumper sticker on his car. "Life is great," it reads. "Business is terrific. People are wonderful."

* * *

EXECUTIVE SUMMARY

THE COMPANY:

Puff Pac Industries Inc., Valencia, Calif.

Concept: Capitalize on landfill crisis and environmental concern, with new, balloonlike packaging product that reduces waste from industrial-packing materials by more than 90%. Further leverage product by selling decorated versions as inflatable gift wrap

Projections: Combined sales from industrial and retail customers of $16.5 million in 1992, rising to $78 million in 1995. In 1991, loss of $1.3 million on revenues of $2.1 million

Hurdles: Assuring users that packaging in inflated bags is as effective as established methods such as foams, bubble wraps, and polystyrene peanuts; developing a reliable production process; raising enough capital to install adequate manufacturing capability

THE FOUNDER

Dan Pharo

Age: 40

Family: Married, two children

Source of idea: Accidentally overinflated a balloon

Personal funds invested: $125,000

Equity held: 27%

Salary: $50,000

Education: Art and business major at Arizona State University; dropped out a year before graduating

Other companies started: Exotic Woods Inc., 1974-1977; Grapevine Tables Inc., 1977-1980; Dan Pharo Studio, 1981-1985; Yuppie University Inc., 1985-1988

Last job held: President, Yuppie University Inc.


FINANCIALS

Puff Pac Industries Projected Operating Statement

(in $ thousands) 1991 1992 1993

Retail sales (gift wrap) $1,909 $8,000 $18,000

Industrial sales 230 8,500 17,000

Net sales 2,032 15,675 33,250(after returns and discounts)

Cost of goods sold 1,363 9,092 19,285

GROSS PROFIT $669 $6,584 $13,965

Other revenues $27 $1,465 $1,889(licensing, royalties, machinery)

EXPENSES 1991 1992 1993

Salaries and benefits $426 $1,075 $1,800

General and administrative 749 1,050 2,000

Marketing and promotion 331 600 1,000

Sales commissions 244 1,568 2,660

Research and development 59 627 998

Depreciation 180 650 1,400

NET INCOME (LOSS) ($1,293) $2,479 $5,997

Before interest and taxes


WHAT THE EXPERTS SAY

COMPETITOR

BILL ARMSTRONG

Technical-development manager, Sealed Air Corp., in Saddlebrook, N.J., a $450-million company that manufactures bubble wrap, foam cushioning, and other packaging materials

In this market, customers start with performance. What will give them the packaging protection they need for the length of time required by their distribution channels? Then they look at the cost of materials, at labor and shipping costs, and at the damage rate. Then they start thinking about the environmental side -- disposability at the other end. Normally, those other factors will prevail. To make the protection more disposable doesn't do any good if you break more products. So those factors are all weighed together, and to lean on one or two of them alone and assume you can make a major impact on the packaging market is, I think, a little naïve.

How do you inflate these things in a fast-moving production operation? Who blows them up? Do you need to dry the air? Those are real issues when you're trying to replace things like polystyrene peanuts, which you just dump into a box. The ability of the packers to understand this operation is critical. They want simplicity.

And what about shipping at high altitude? Bubble wrap isn't inflated; it just traps the air -- and the bubbles look very good in Denver. Puff Pac bags, though, are under positive internal pressure. When atmospheric pressure drops, as in the cargo hold of an aircraft, those balloons might expand.

There is an appeal to this inflatable-package concept, and I think there probably are market niches that the company can tap. But a lot of Puff Pac's selling points involve things other than the product itself -- environmental concerns, for instance -- and the product must come first.

OBSERVER

GREG ERICKSON

Editor-in-chief of Packaging Magazine, a monthly trade journal headquartered in Des Plaines, Ill.

Whenever you can eliminate layers of packaging material without excessively lessening the protective quality of the packaging, you are doing yourself and the environment a favor. But there is a fine line between trying to eliminate unnecessary packaging and making sure you'll still protect the product being shipped. First and foremost, Puff Pac's bags must perform well.

The product's environmental edge is not all that clear. When it comes to determining which materials are environmentally friendly or unfriendly, you really have to dig far deeper than this story could go. Great strides have been made to recycle bubble wraps and foam peanuts, and some manufacturers have been advising their customers to reuse these materials when shipping products themselves. Plus, some of the materials that seem environmentally burdensome still provide the most efficient form of packaging yet devised. This is a difficult and complex issue.

I also would question Puff Pac's cost-effectiveness. Long after all packaging materials become recyclable, people are still going to be looking for value for their dollar. Everybody is trying to reduce costs, and what people want is a material that will perform well at a price they can afford. Even if Puff Pac's bags are environmentally advisable, you can't assume people are going to pay more for them. Puff Pac needs to show how it can help customers save money.

CONSULTANT

BARBARA KECK

President of Keck & Co. Business Consultants, an Atherton, Calif., firm specializing in marketing consulting for the packaging industry

Puff Pac shows many signs of being a typical company in the packaging industry. It's technology-driven, is short on planning, and has given little attention to marketing in its early stages. It also tends to give away too much margin to middlemen or licensees. Licensing agreements that seemed to provide good paths into overseas markets have often come back to bite people.

The gift-wrap business is likely to be faddish and seasonal, with a short life cycle. The industrial-packaging business is likely to be where Puff Pac's bread and butter comes from in the longer term. It will be steady but will undoubtedly have lower margins.

Puff Pac should be careful about environmental hype. Admittedly, the regulatory-legislative-awareness window is open wide now, but there are traps. Industry veterans are betting on the development of materials that are environmentally friendly and easy to recycle, which would negate any perceived advantage Puff Pac now claims.

So quality needs to be Puff Pac's religion in the industrial-packaging market. There's too much at stake for manufacturers of high-value items -- electronics, say -- to risk breakdown of their transport packaging system. The first time Puff Pac sends a shipment of bags that don't hold air is the last time it'll hear from that customer.

Overall, the company has to decide what it wants to be. A manufacturer? A licenser? Many of its imminent problems will arise from its uncertainty on this score. It's the old case-study question: What business are you in?

Last updated: Feb 1, 1992




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