It's About Control
Virtual corporations may be "in" these days, but here's one company founder who sings the praises of vertical corporations. And he's tried both
I jumped on the virtual-corporation bandwagon way back in 1981. Outsourcing everything seemed like a near-perfect idea to an entrepreneur who considered any business with more than 10 employees to be midsize. When my partner, Terry Brown, and I raised the start-up capital for AC International from nonactive, outside investors and opened our doors with no employees, we were the model virtual corporation.
To be clear about our beginnings, I should say that Terry and I owned other companies that provided us with a living. Terry had a manufacturers' rep company with the catchy name of National Sales Headquarters. I was running a distribution company specializing in bicycle accessories. We met when I called his company to inquire about one of his products. When we opened AC International, two years later, even we were not employees. How much more virtual can you get?
We created the company to manufacture and distribute a patented product called Mr. Tuffy, a bicycle-tire liner that stops puncture flats. We outsourced the manufacturing to a job shop, the packaging and distribution to my wholesale business, and the sales and billing to Terry's company. Each billed AC International for services rendered.
AC International grew by adding other products from domestic or foreign manufacturers. The company looked like a wholesaler but behaved like a manufacturer. We controlled the packaging, marketing, advertising, and product development. But we employed no engineers, artists, accounting personnel, marketing managers, or salespeople. Most important, we owned no production equipment and had no labor overhead. Since my degrees were in psychology and law, and my partner's degree was in sociology, we weren't exactly candidates for manufacturing anything, anyway.
What had seemed like a panacea, however, began to spawn trouble. Our customers were constantly on the phone, complaining about late shipments and back orders. We, in turn, were always screaming at our suppliers for not keeping their promises. Their excuses may have been valid, but their always being behind in shipping didn't help customer relations or sales.
The two worst days in my business career were both caused by the plight of the same manufacturer. We had gone out on a limb financially with an advertising campaign introducing a new bicycle helmet. The first shipments were late and sporadic, and there were some quality issues, but the manufacturer was improving. Unfortunately, just as the season got under way, the factory was hit with a major fire. It was out of production for only about six weeks, but it might as well have been six months. Then, within three weeks of its being back to full production -- and at the pinnacle of our selling season -- a second fire completely destroyed the facility. Tell that to your customers.
Soon after, our most important job shop went bankrupt. It was responsible for manufacturing, packaging, and shipping the product upon which the company had been founded, Mr. Tuffy. We hastily concocted a plan to have the owner of the job shop become a contract laborer for us. He would supply the equipment and oversee the management. We would supply the labor and facilities. Almost immediately, our shipping improved, and our costs went down by more than 25%.
We later purchased a patent for a bicycle-tire-changing tool from the company that had been making it for us. Our cost dropped by more than 75% when we began making it ourselves. We kept the sale price the same, so margins jumped by 67%. Our monthly payments to the patent holder were substantially lower than the savings. We began to think we were onto something!
By our ninth year we had 35 employees, ranging from manufacturing labor to an international sales manager. We had a full-time staff artist, and in-house sales personnel handled more than 50% of our sales.
Yet our big break from outsourcing was still to come. We were purchasing more than 30% of our finished goods from Hong Kong, Taiwan, and domestic job shops. We had developed a reputation for being interested in pioneering new items, and in 1989 we purchased a bicycle-water-bottle manufacturer. The company founder had come to us for help in getting his product to market even before he had his tooling complete. He had run out of money and patience, and for small monthly payments and future royalties, we were able to purchase the tooling and the ideas. Our favorite kind of deal.
Still buying into the promise of letting suppliers do it, we outsourced the blow molding of the bottle, the injection molding of the caps, the silk-screening of advertising matter on the outside of the bottle, and the film work needed to create the screens.
The blow molder told us he could make a certain quantity of bottles each month, and we took orders based on his number. Incredibly, by the third month we had two months' worth of back orders. His excuses went from questionable to unfathomable. His equipment was broken down so much that we began to suspect that other (more profitable? faster paying?) jobs were causing the "equipment failures."
We immediately began looking for our own blow-molding equipment, and within 60 days of our decision to do our own molding, we were making the quantity of bottles the job shop had promised and never delivered. The cost was halved (even after factoring in overhead).
Our bottle-cap maker was in Taiwan. Because of the variety of colors we offered and the 70-day lead time to get the caps, we constantly found our inventory out of balance. Our airfreight bill skyrocketed because we had to fly in missing chunks of cap inventory to keep our customers from totally losing their sense of humor. So we bought a second injection-molding machine and started making our own caps. Of course, the cost dropped. This time the savings were 80%. With all manufacturing now on-site, we increased the number of colors offered, said good-bye to the inventory problem, and gained a major additional competitive advantage.
Most bottle printers we talked to weren't even interested in our short runs and the difficulties of printing on a soft surface. We decided to bring printing inside. Our quality and turnaround time improved. However, we were still at the mercy of the photo shop to produce our film positives and the screen makers to burn the screens. Each might take anywhere from one to three days. If there was a problem with the film or the screen, there was a fight about who was responsible and an additional delay to remake the screen. It didn't take a major management decision to conclude that we should build our own photo lab and install screen-making equipment. Today a customer can provide us with a sketch on a napkin, and within four hours of receiving the art, we can have a printed water bottle. You guessed it: the cost of a film positive dropped by 80%, and the screen burning by more than that. Clearly, we were seeing that ownership of production was giving us control over timing, which translated into better customer service. The benefit on the cost side was even more substantial.
Along with all the cost cutting and the control of production timing came dramatic improvements in quality. The outside vendors had always had difficulty controlling color from batch to batch. The cap maker in Taiwan saw neon yellow differently from the way the bottle maker in Los Angeles saw it. If the bottle leaked, which one did we blame?
All these changes did not happen without any hiccups. We have had a learning curve with each new operation we've added. But during this five-year period, we have gone from making a few thousand bottles a month to being the second-largest maker of bicycle water bottles in the world, with shipments of more than 5 million units expected in 1994, including container loads of bottles to our customers in 30 countries.
There are certainly business opportunities and situations in which the virtual corporation makes sense. (We still use temporary labor for seasonal work.) There is also a limit to how vertical a company can become. AC International is not going to be manufacturing its own plastic resins or even packaging materials. But when it comes to control of quality, delivery, and cost, this entrepreneur (who still doesn't even know how to find the on-off button on one piece of our equipment) believes the outmoded and politically incorrect concept of the vertical corporation should be dusted off and included in the list of options for sources of products and services.* * *
Randy W. Kirk is president of AC International, in Santa Fe Springs, Calif. His most recent book is When Friday Isn't Payday (Warner Books, 1993).