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Breaking Away

The CEO of a spin-off discusses the opportunities and dangers of spinning off a business from a major parent company.
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How does a service department in a billion-dollar insurance conglomerate become an entrepreneurial company overnight? So far spin-off founder Dan Logan seems to have the answer

"Here are three ways of getting information -- elicitation, observation, and penetration." Dan Logan, between bites of duck salad, is explaining what he learned in intelligence school before spending three years overseas as a military attach&eacuate; in the 1970s. The techniques served him well in those days ("If someone was trying to kill me, they failed," he says without irony), and they have also come in handy in his latest career maneuver: jumping easily from the most staid of corporate environments into the maelstrom of entrepreneurship. Unlike most start-up entrepreneurs, Logan didn't begin from scratch and enter the marketplace with a blank slate (and an equally empty bank account). Instead, he launched a covert operation inside his old company that enabled him to jump-start his new business, which thus began life with significantly more assets than is typically the case.

A stone's throw from the Boston restaurant where he is lunching stands the stolid granite building housing the New England (TNE), the nation's oldest chartered mutual-life-insurance company and Logan's former employer. Three summers ago, in July 1992, Logan began to deploy his information-gathering techniques, particularly elicitation, which he describes as "getting information out of people without them knowing you're trying to get it." As head of the insurer's internal communications department, Logan, like all department heads, had been told to find ways to cut costs and reduce overhead. At the time, his 90-person department was spread over two floors of TNE's block-long Back Bay headquarters and had an annual operating budget of $5 million. Packed into cubicles, Logan's group handled all the communications needs -- from annual reports to direct mail to training videos -- of the 165-year-old, 2,800-employee company and of six of its separate business units.

Logan talked with those internal customers and used his best spy manner to gain information while planting the seed of an idea in their heads. He asked about their problems and then, after hearing them out, he wondered aloud whether they thought an outside firm that understood their business could help them with solutions.

In that fashion, Logan began to covertly lay the groundwork for his life as an entrepreneur. Though he had spent the previous 20 years as a corporate vice-president -- 8 at TNE and a dozen before that at a New York City advertising agency -- entrepreneurship had long been on his mind. In 1984 TNE lured him away from the agency by offering him the opportunity to build his own department there from scratch. The company gave him generous corporate resources to turn what had been a seven-person skeletal crew into a full-service communications department. But coming from the informality of the advertising world, he quickly discovered that adapting to the culture of an insurance company was going to be a stretch for him. "You learn the art of having dinner for three hours and never saying anything," he says.

Nevertheless, Logan spent the next several years using TNE's corporate resources to build his group into a model department: he computerized all systems, instituted time reports and detailed financial breakdowns, and enrolled his employees in courses in public speaking and business fundamentals. In the fall of 1990 TNE asked him to spearhead its quality initiative and flew him around the country to examine leading-edge management practices like total quality management, peer review, team-based project management, and outsourcing, as practiced by such companies as IBM, Federal Express, and Corning Glass. Eventually, the company even adopted some of those techniques. Over time, however, Logan came to believe that he had been unrealistic to hope that a tradition-bound New England-based insurance company that was a century and a half old could ever turn itself into something lean and sleek. "They don't want to be out in front of these things," notes Logan.

Logan decided to view TNE's chaotic reorganizing effort as his opportunity to become a real entrepreneur -- but without having to go cold turkey, so to speak. TNE had been good to him, letting him run the department almost as if it were his own, all the while paying for all the training and equipment he needed. In return, the company asked only that his department break even and that Logan play by its rules. Now it wanted him to cut his costs, so how could it object if he eliminated them by shutting down his own department?

Logan would quit. He'd even forgo the generous severance package TNE was offering departing employees as part of its downsizing effort. There was just one thing he wanted: his department and its business.

Logan needed a highly placed ally, and he found one in Jim Zilinski, the senior marketing officer to whom Logan reported. Zilinski, a member of CEO Bob Shaffto's senior team, was as eager as anyone to cut corporate costs, and he trusted Logan's instincts well enough to help him make his case. "My job was to be supportive and run interference," says Zilinski, who has since left TNE himself to become president of Berkshire Life Insurance Co., in Pittsfield, Mass. Next, Logan needed to do reconnaissance work -- "observation" in spy parlance -- on corporate spin-offs. He found a conveniently local example at Digital Equipment Co., in Maynard, Mass., and spent several days with the person who oversaw the breaking away of that company's communications department. "He told me to move quickly and clearly once I made the decision," recalls Logan. "Otherwise, corporate resistance would build up, and the effort could get bogged down."

The key to moving quickly to a successful launch, Logan and Zilinski decided, was to create a business plan "that would enable the new entity to be in business instantly," Zilinski recalls. The proposal would have two objectives: first, it would need to demonstrate the economic viability of a breakaway start-up; second, it would need to show TNE cost savings with no loss of quality.

How does a corporate department become an entrepreneurial company overnight? Logan decided that having partners would make the conversion easier. It didn't take him long to line up three senior-level TNE employees ready to take the plunge: Jim Kerley, a 23-year TNE veteran with a thorough understanding of how to sell the insurance company's products; Nancy Michalowski, who excelled at client services; and on the creative side, Sue Wolski, TNE's director of design and photography services.

The core team tackled the issue of economic viability. Obviously, clients were crucial, and the favorable reactions Logan had elicited earlier from his internal TNE clients suggested that the new venture could count on them as customers. As for the services the new company would provide, the team agreed to take with them the creative and communications functions while leaving behind equipment-based work, such as darkroom operations, and work that was heavy on administrative chores, such as the preparation of annual reports. They figured they would need to bring at least 20 TNE employees with them to start. As Michalowski describes it, "We were looking for people who were entrepreneurial by nature -- who didn't need a lot of supervision or support staff, who were flexible, willing to learn and try new things and chip in to get the job done."

Working at TNE gave the team the luxury of cherry-picking the new venture's customers, services, and employees, but it also entailed a major headache. The four would-be founders were still full-time employees with regular jobs to attend to -- and they had to keep news of the breakaway project under wraps. Starting in July 1992 and for the next two months, Logan and his team would meet daily after work and on Saturday mornings. They avoided using electronic mail and the telephone as much as possible; all copies of written correspondence were destroyed. Nearly lost in the shuffle of duties was the selection of a name for their proposed company. Over a late-night huddle on the eve of the 7 a.m. deadline their lawyer had given them, the four settled on "Trinity Communications" because it was easy to say and, they hoped, made it sound as if they had been around a long time. "It was a long summer of meetings, memos, and crunching numbers," recalls Michalowski.

Remarkably, the team members shared similar visions of the kind of company they wanted to create. "We wanted to take the things that worked well at TNE and improve or discard the ones that didn't," Kerley remembers. The former included placing a premium on training and technology, pro bono work, community involvement, and what Logan calls "the Baldrige stuff." They would measure customer satisfaction with surveys accompanying each project, and when possible, they would track each project's effect, if any, on the customer's sales. They would monitor employee satisfaction and encourage feedback through a team-based peer-review system. The management structure would be flat. Everyone, including the four founding partners, would be titleless to give more credence to the term peer review. Open-book management and stock ownership for all employees would heighten the feeling of teamwork, with a group of equals striving for a common goal. Creating the kinds of process and cultural changes that would have entailed years of struggle at TNE could be done overnight in a spin-off. "You can move faster because there's no resistance to overcome," notes Logan.

* * *

On January 3, 1995, at 7:30 a.m., Dan Logan, the untitled but de facto president of Trinity Communications, and Tom Simons, the founder of another agency (Boston's Partners & Simons), were breakfasting at the Ritz Carlton, "sharing notes and nervousness, and talking through the challenges of the coming year," recalls Logan. Except for the waiter, they were the only people in the room. Afterward, says Logan, "we asked ourselves, 'Are we so obsessive and compulsive that we're the only two people having a breakfast meeting on the first business day of the year?"

Logan shares the story to illustrate one difference he's had to confront between managing a corporate department and running a small business. It's been a shock to start each business year knowing that his company's committed expenses exceed its certain revenues.

* * *

Since Trinity opened its doors, on January 1, 1993, its revenues have surpassed its expenses by a comfortable margin. (See the company's financials below.) During its first two years Trinity has put more than half a million dollars into its bonus pool and $700,000 into retained earnings. It has invested more than $200,000 in technology (all 40 employees have PCs at home and are hooked up to the Internet) and $50,000 on redecorating (adding modern hanging light fixtures, purple chairs, aqua carpet, and some funky furnishings to camouflage the corporate furniture it inherited from TNE). Trinity has also spent 1.5% of revenues annually on training. To generate those dollars, the company provides a full menu of communications services -- advertising, public relations, research, event marketing, direct marketing, and multimedia design -- for a growing list of clients that includes TNE and other members of the Boston financial community such as Putnam and Bank of Boston, as well as corporations such as Lotus and Cahners Publishing.

Logan gives substantial credit for Trinity's early success to its corporate parent. Thanks to TNE, the spin-off set itself up in a new office building one block from its old home, with substantially more assets than a typical start-up: 21 former TNE employees, $100,000 worth of computer equipment, office furniture, access to the insurer's army of lawyers and accountants, and most important, a $500,000 advance on a $2.2-million contract for 1993. "TNE very much wanted us to be able to survive on our own, like a parent wanting to see a child grow up," recalls Logan. TNE had approved Logan's proposal in September. To ease the transition, the group that would become Trinity moved into its new space in November but remained on the insurer's payroll through the end of the year. As a result, says Logan, "when we opened our doors, we didn't have any problems on our hands other than helping TNE and getting new business. We didn't have anything distracting us from getting it." And a good thing that was, too. By Logan's calculations, without any new business Trinity would have posted a $300,000 loss during its first year. Instead, it picked up its first non-TNE client within 90 days.

Both Trinity and TNE have gone through a period of adjustment, exploring their new relationship. Trinity is learning how to satisfy TNE as a customer rather than as an employer. At the same time, it's taking great pains not to let its ties to TNE jeopardize its efforts to be perceived by its other clients (as well as prospective ones) as a real, open-for-business creative communications company -- a critical task for a young company in an industry in which image is paramount. While it welcomes the financial-services work it gets from TNE and through TNE referrals, the start-up actively courts diverse types of new business: for example, identity work for a small Chinatown restaurant, a handbook on gay and lesbian issues for the Massachusetts Department of Education, and a newsletter for a hotel in Bermuda.

TNE, too, is on a learning curve, adjusting to working with Trinity as a vendor rather than as an employee. TNE executives couldn't argue with the math: breaking out Logan's group enabled TNE's communications department to shrink from a 90-person, $5-million department to approximately 35 people today. Its $3-million budget includes the work it now outsources to Trinity and other agencies.

Clearly, it was in TNE's best interest that Trinity succeed, and the insurer went to great lengths to bolster the start-up's viability. In addition to providing the "dowry" of assets, TNE agreed to pay Trinity quarterly and in advance for its services. However, TNE didn't want to be generous to a fault. Both parent and offspring agreed to split 50-50 any profit Trinity earned on the insurer's work for the first year. Explains Dick Harris, a TNE senior planning consultant and Trinity customer: "Internally, you tend to get a little soft around the edges. Releasing them forced us to get a lot more thoughtful and critical and ensure that we are getting the most for our dollar." TNE's agreement with Trinity also gave the insurer freedom to use other outside vendors, and TNE has steadily reduced the amount of work for which it contracts with Trinity in advance -- from $2.2 million in 1993 to $1.8 million in 1994 and approximately $1 million in 1995. Other business between the two companies is done on a project basis.

The start-up is moving out of its parent's shadow, financially and psychologically. Whereas TNE business accounted for 75% of Trinity's revenues during its first year, it amounted to just half in 1994 and should come to no more than 25% this year. "Within a year that 'insurance department feeling' was almost entirely gone," notes former TNE and current Trinity employee Mary Heissner.

In client acquisition, it helps that the parent doesn't own even a small piece of Trinity. Says Michalowski, "I'm not sure anyone would have taken us seriously if we were a division of TNE." It also helps that Trinity had moved into a different building. TNE's marbled foyer with murals depicting scenes from such events as the Boston Tea Party doesn't project the image a creative communications company would want to cultivate.

The breakaway entrepreneurs have been surprised by the amount of help they've received in the start-up process (from TNE, from friends, from consultants) in the form of recommendations, leads, and advice on health-care and retirement plans, technology, even specific types of Xerox machines and phone systems -- "all that stuff that you have to do but you don't want to do," says Logan. Adds Kerley, "A lot of times start-up companies or small businesses just don't ask for help, but if you try to get it, it doesn't have to cost you a fortune."

Among Logan's benchmarks for success is sustaining an above-average profit and a below-average turnover rate for his industry. He estimates that Trinity's annual pretax profit margin of 20% to 25% puts it in the top third of ad agencies and is a healthy notch above the industry average of 10% to 12%, while its personnel turnover rate, 10% a year, is significantly lower than the 20% to 25% common for the industry.

Another important benchmark is client satisfaction, and in two and a half years Trinity has yet to lose a customer. Furthermore, Trinity is adding new clients at a healthy clip: midway through 1995, the agency had picked up $900,000 in new business -- roughly 20% of projected 1995 billings.

Entrepreneurship has given Logan the freedom to behave in an entirely new way: to add pizzazz and joie de vivre to the workplace. Undeniably, he has TNE to thank for much of that. Breaking away with assets in place -- not to mention a customer with cash -- is a far less painful way to become an entrepreneur than starting a business from scratch. Logan is the first to admit that, and he refers to Trinity's unique heritage as "a luxury." One gets the sense that he still pinches himself and wonders if it's all too good to be true: "I wake up in the morning and I look forward to going to work. At times in a corporation, you don't feel that lightness. With Trinity, it's more of an intellectual challenge than a depressing burden. It's invigorating."


EXECUTIVE SUMMARY

Company: Trinity Communications, in Boston, founded by Dan Logan, former head of the New England (TNE) insurance company's corporate-communications department

Concept: Spin the TNE department off as an independent, employee-owned communications company. The breakaway start-up retains its former employer as a client but seeks to grow by expanding its client list.

Projections: 1995 revenues of $5 million; $7 million by 1997

Competitive Advantage: As a breakaway, Trinity started out with significantly more assets than a typical start-up does -- capital, customers, employees, equipment, a proven track record, and a reputation. It was a going business the day it started.

Hurdles: Overcoming its reputation as an insurance-industry specialist -- without offending TNE, which gave it birth. Trinity must generate enough new business to offset the gradual loss of TNE work and to prepare for the inevitable day the insurer shifts all its business elsewhere.

THE FOUNDER
F. Daniel Logan Jr.,
age 50

Family: Married, with two children

Personal funds invested: $0

Equity held: 23%

Salary: Comparable with a TNE vice-president's, plus stock ownership and an incentive bonus

Previous jobs held: Spy (army intelligence); senior vice-president with New York City ad agency, in charge of M&M Mars and Coors accounts (among others); director of the New England's marketing services division

On being an employer: "I don't see myself as an employer, even though I suppose that technically and legally I might be one. I see myself as one of 40 people trying to figure out how we want to spend our time."

On running a company versus an internal corporate department: "It's weird to start your year off knowing that you have more committed expenses than certain revenues. It's either get new business or go out of business -- which adds a certain urgency and intensity to the importance of achieving our goals."

Recommended reading: Customers for Life, by Carl Sewell. "It's about implementing the stuff academics conceptualize. You can read Sewell and trade up to the philosophy."

On office decor: "They came in and told me I was going to have purple chairs. I went along with it."


DAY ONE: THE ADVANTAGES OF BREAKING AWAY

The breakaway start-up begins life with employees, customers, revenues, capital, a track record, and a reputation already in place -- in contrast to the typical start-up, which rests on nothing but the founder's vision.

Financials

(in $ thousands) 1993 1994 1995* 1997*
Revenues $3,500 $4,500 $5,300 $7,000
Costs $2,800 $3,500 $4,300 $5,500
Pretax profit $700 $1,000 $1,000 $1,500

*projected

Rarely does a new advertising agency turn a profit during its first year. Not only did Trinity, as a breakaway, send money to the bottom line, but its 20% margin was twice the industry average for established agencies.

Where Dan Logan thinks year-one operating costs differ

(Costs given as a percentage of revenues)

(Typical Agency Start-up) (Trinity)

Technology 3.5%Ñ4% 0%Ñ1%
Training 1.5% 0%

"I can't believe any other start-up spends money in these areas. We look at this investment as a competitive advantage -- a lesson we learned at TNE. While our investment in training doesn't look like a lot in hard dollars, it is significant, considering that any training at all is rare for most advertising agencies."

Salary 47% 55%

"We saved money by having no administrative overhead or large management structure. Our salaries may have been lower initially, but we compensated by giving people ownership."

Benefits 4%Ñ6% 8%Ñ10%

"Coming from TNE, we had enough knowledge and sophistication about health care, 401(k)s, and retirement plans to enable us to shop around and get a really good package."

Cost of Capital 0% Prime plus 2 points*

"It's a miracle we didn't need to borrow any money. We were most fortunate that way."

* As of 9/7/95


WHAT THE EXPERTS SAY

Karen Hopper Wruck
Associate professor of business administration at Harvard Business School
Many companies find improving efficiency in operations easier than improving efficiency in internal service departments. Harnessing market forces to discipline both the department and its customers can provide a simple solution. For example, a company can allow internal customers the option of outsourcing work and force the department to charge a price and be evaluated on profitability. A more radical approach allows the department to sell outside as well. The extreme case is to disgorge practically the entire department, as TNE did with Trinity. How should a parent choose among alternatives? Important questions to address include, Is our department really providing specialized services unavailable from an outside vendor? If so, is the benefit from specialization worth the inevitable loss of efficiency? If we decide to spin off a department, what is it worth? In spinning off Trinity, TNE took a radical, market-oriented approach to restructuring, but I question whether it might have charged Trinity managers a higher "price" and insisted on an equity stake. It appears that Trinity managers were presented with an attractive business that was subsidized and insulated from many risks normally faced by entrepreneurs. For them, it was a fantastic opportunity.

Jerry Della Femina
Advertising guru; chairman, CEO, and creative director of Jerry & Ketchum, in New York City
The only thing I would have done differently would be to try to get a longer contract from TNE. It's always disappointing to bring something to people, see them enjoy it (and save millions of dollars), and then have them say, "Thank you very much, we're going to someone else." On the other hand, maybe in the long run it's good not to be so tied to one giant master. With everybody downsizing, Trinity may have hit on something -- becoming the in-house/outside agency. Think of all those sleepy old companies all over America that have giant communications departments, that are there only because they have been there for 50 years. I was impressed by Trinity's example: it provides giant, sleepy corporations with a way to save a lot of money, downsize, and get out of a business they really shouldn't be in. A lot of other people in corporate communications should look at this and say, "Why don't I try this at my company?"

Karen Green
Director of marketing and senior executive vice-president, BayBanks Inc., in Boston
Trinity will prosper if it continues to diversify its client base and finds a way to improve margins without sacrificing quality. Logan will want to review fee structures to ensure that costs are covered. Moreover, planning has never been more important than it is right now. If Trinity expects to continue its impressive rate of growth, it will need to explore alternative funding sources, since not all clients will agree to pay fees up front. Sustainable growth is contingent upon three key factors: a reputation for good service, aggressive self-marketing, and adequate financial resources, including access to credit.

James X. Mullen
President and CEO of Mullen Advertising, in Wenham, Mass.
Dan Logan is not only a competitor but a friend and a former client, so it's easy to admire his volcanic entrepreneurship and sudden success. Still, it's one thing for a newly messianic entrepreneur to trim corporate bloat -- 77% fewer people managing 40% less business -- and another to build an agency that sustains enduring and profitable growth in this hard, cut-and-thrust world of advertising. For instance, how much of those fat profits are due to the fact that virtually all of Trinity's initial physical and operating investments were handed to it debt-free? Are Trinity's earnings evenly spread across all its business segments, or does the account inherited from TNE still contribute disproportionately to the bottom line? What will happen to Trinity's momentum when it does lose a large piece of business, say, TNE itself, in one fell swoop?

In the long run, though, I'm betting on Trinity to help make New England's advertising community stronger, better, and more distinguished, as well as to make things a little tougher for all the rest of us.

Last updated: Nov 1, 1995




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