Margins, in fact, were coming down as fast as Theye could acquire struggling competitors and grow their sales. Five years ago TFN generated gross margins of 22% on hardware sales. Last year that number was 8%. Net margins, already thin, were growing anemic. From 2.2% in 1991, net profit was nearly halved, to 1.3% in 1993. Last year was especially brutal. The company took a $40-million write-down after all its acquisitions. "We had a lot of duplication in warehouses and distribution," explains Theye.
In the midst of its heavy acquisition phase, when it was dangerously close to draining its reserves, TFN had found a financial savior in Dick Sanford, the acknowledged godfather of the computer-reselling industry. Sanford is the founder and chairman of Intelligent Electronics, a $3.2-billion "master reseller," or distributor, of computers. At that time TFN bought nine stores from IE in exchange for stock. "It got us key financing so our business model would survive," says Theye.
Unlike its competitors -- virtually all of whom are under water or in the throes of restructuring -- IE sits above the fray with $140 million in cash on its balance sheet. Sanford has always been allergic to debt and dismissive of those who grow dependent on it. "We don't believe in banks," says Sanford. "Our company is driven toward not getting ourselves into a position where we have to go to them." Of his industry peers he says, "Most of these companies are way underfinanced. Only the organizations that are well financed and well connected will survive."
Sanford intends that TFN be well connected -- and that it survive. Last year Theye, faced with a cash crunch, turned to IE once more. "We had a liquidity problem," says Theye dryly. "Sanford solved it by helping little brother. He infused $40 million in cash into our business, and we gave him five of the nine stores back."
That $40 million proved to be just an ante. In March IE and TFN agreed to merge, in a swap of each other's stock.
The relationship between the Future Now and Intelligent Electronics reveals Theye's latest strategic maneuver in a turbulent marketplace -- vertical as well as horizontal consolidation. TFN will now buy most of its hardware from IE, making it, in effect, TFN's warehouse. That eliminates TFN's inventory risk. "There's no reason for Terry to carry inventory at 26 locations," says Sanford. "It's absurd. Why don't I hold it and ship it to him? He becomes over time the representative of services to manufacturers. He has outsourced a lot of his costs."
And that offers TFN a welcome flexibility in the fast-moving hardware market, in which technology turnover occurs every six months and, as Hummel notes, "product obsolescence is the grim reaper." In 1994 Hewlett-Packard introduced 65 new products, while Compaq and Apple each brought out 50, according to Carolyn Ruech, TFN's vice-president of marketing. Resellers dread getting stuck with obsolete inventory or, conversely, clearing out old inventory while not having the new machines on time. With IE as his big brother, Theye no longer has to worry about either predicament.
Furthermore, "Dick Sanford is so big that he's got the attention of the major manufacturers," says Hummel. As a result, manufacturers are not about to overstock inventory or let it get obsolete. That would clog a huge channel for new product offerings.
The IE-TFN combination promises big numbers. Sanford plans for IE to become a $10-billion company by the year 2000, with TFN, headed by Theye, as a $3-billion-plus subsidiary. Sanford and Theye hope their combined clout will give them the economies of scale they have been so desperately pursuing.
With the merger Theye will be able to count on IE to give him efficiencies on the hardware side. Too bad that's not where the profit is anymore.
* * *
Phase Five
Chasing Fat Margins:
Leaving Hardware Behind
What Dick Sanford, the godfather, has allowed Terry Theye to do is, in essence, offload all the risks associated with hardware. Theye's current business model embraces the opportunities that software and related services present, which is where future value lies.
To hear Theye tell it, TFN today is an $800-million company selling little more than air. Keeping that air rich with the oxygen of decent margins is the trick. "We need to stay at the leading edge of technology, and that really means staying at the leading edge of software and consulting services," says Theye. "The days of making money on hardware are long gone."
It was a good five years ago that Theye, with the millstone of hardware hanging heavy around his neck, began moving the company upstream into the consulting and software-services markets. Last year services accounted for 9% of sales but 40% of gross profit. Gross margins on professional services are 35% -- or more than four times greater than gross margins on hardware.
But within that promise there still lurks the same old hook of compressible margins. Hummel explains that TFN "needs to stay at the leading edge of the services envelope." In other words, high-skill services relating to integration and networks bring good profit because the demand for technical assistance currently outstrips the supply of technical assistants. More traditional "break-fix" services, says Hummel, "are break-even at best," down from 30% gross margins just five years ago. That creates new pressures.
