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OUTSOURCING

Rules of Engagement
 

A close-up of a company that understands that the most important part of an alliance is the people involved.
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Strategy

Jim Nichols may have discovered what those fashionable theories about alliances leave out: people matter most

On a June morning in 1979 Jim Nichols looked out the window of his new house and watched a business idea rise up from the ground.

To anyone else, it might have looked more like a domestic horror. And Nichols himself didn't immediately grasp its moneymaking potential: after all, what he saw was that the ground was oozing and bubbling as the result of a failing septic system. Nichols, a plastics-design consultant who had recently moved to Old Saybrook, Conn., pulled the name of Sid Holbrook from the yellow pages. Holbrook made his diagnosis quickly: Nichols needed to replace the part of his septic system that allowed waste to flow safely from the tank and into the soil--an underground, gravel-lined trench laid with pipe, called a leach field.

As Holbrook described the problem Nichols pondered the financial consequences; not the $1,300 it would cost to restore his backyard to terra firma, but the fortune he could make coming up with a more reliable alternative. "Being a guy, I was out there watching that backhoe, and Sid and I got to know each other a little bit," recalls Nichols. "He was a very unusual man for a septic contractor." Holbrook, as it turned out, possessed the kind of broad thinking that Nichols appreciated. Nichols himself was a habitual tinkerer. "We could probably come up with something better in plastic," he mused. Holbrook was intrigued. "I could see that Jim was looking at the problem through the eyes of an inventor," he recalls. "I told him, 'When you're serious about that, come to me, and I'll help you raise the money to do it."

Maybe Holbrook meant it; maybe he just wanted his bill paid promptly. But Nichols kept dropping by to see him, showing him various designs for a septic chamber composed of plastic. "He was very persistent," says Holbrook. "But I was never really impressed until he showed up with the design for the Infiltrator." Today Holbrook and nine other private investors (none of them venture capitalists) own 35% of Infiltrator Systems, the $50-million manufacturer of septic chambers that Nichols started eight years after that initial conversation.

It might appear odd that it took Nichols so long to start Infiltrator Systems or that Holbrook didn't just tell him to scram after stamping his invoice "paid in full." But Nichols offers a simple-sounding explanation: "He and I formed a relationship." To understand what he means by that, it's important to know that Nichols takes such ties very seriously; his ability to not only form but also manage a web of what he calls "relationships" has been the key to growing his business. What's more, it may very well prove to be Infiltrator Systems' most effective competitive weapon.

No, Nichols isn't alluding to strategic alliances, corporate partnerships, joint ventures, or any other fashionable form of entanglement. What he's talking about are relationships that start with a spark of common interest and that could eventually result in an agreement to share proprietary technology or in an exclusive distribution arrangement--even Nichols himself never knows how they'll turn out. That's part of what makes his relationships different from the kind of "partnerships" that have become so common in recent years: he doesn't start with an end goal, be it reducing development costs or getting to market quicker. Nichols keeps foremost in his mind what all those contractual contrivances too often downplay: the role of people. Rather than mapping out the shape of the deal, he's most mindful about finding folks who believe in what Infiltrator Systems is trying to do.

It may sound charmingly anachronistic at first--akin to proclaiming the manual typewriter the next great productivity tool. And it's true that Nichols isn't under the same competitive pressure he would be in a fast-paced industry like telecommunications or health care. But he faces daunting challenges: Infiltrator Systems will gain market share only on the strength of its ability to overcome resistance to replacing a decades-old technology.

Nichols's approach is more systematic than it sounds: he homes in on individuals, figures out how he can become part of the way they do business, and then sticks with them; the companies they work for are almost secondary. (For details on his approach, see "The Partnership Track," below.) "People always have latitude in their decisions, and when you're in a gray area, you'll have a much more positive result if you've established a relationship," he reasons.

Obviously, Nichols's relationships are forged with the long haul in mind. What he does is, quite simply, missionary work: having found a disciple--be it an investor or a supplier or a customer--Nichols counts on that person's spreading the word. The people with whom Nichols forges relationships are apparently aware of his expectations, and they live up to them.

If that sounds abstract, consider the words of Dean Ryan, the banker who lent Infiltrator Systems $2 million for a mammoth piece of equipment in 1990. "We are in a risk business, but with Infiltrator we felt we knew what to expect," says Ryan, a senior vice-president of giant Fleet Bank. "They always provided us with so much information: forecasts, budgets, performance, state approvals." Or, as Nichols puts it, "We had always done what we said we were going to do."

Elementary, perhaps--but the rigor Nichols has brought to sustaining relationships has enabled Infiltrator Systems to make the kind of progress he had only glimpsed on that morning in his backyard nearly 20 years ago. More than that, his particular definition of relationships has informed every aspect of the business.

FINDING MANAGERS
Scouting for Qualities, Not Credentials

Nichols has no preconceptions about where or how he might encounter the right "partner." Fancy titles and impressive corporate affiliations have little effect on him; an individual's achievements, goals, and intellectual capital are much more likely to strike a chord. He had recognized admirable qualities in Holbrook, and he also saw them in his sailing buddy George Haines, who, in 1984, had approached Nichols for some midlife career advice. He was a veteran in the financial-services industry, had spent some time as a manufacturer's rep, and was at a crossroads. Nichols saw an opportunity. "George had skills that were complementary to mine," he recalls.

Moreover, the risk-averse Haines was a perfect foil for the aggressive Nichols. "I told George I had a drawer full of ideas and that if he wanted to take the time to do market research to find out which ones were more viable, that maybe we could do something together," he says. Nichols, in the meantime, would continue with his consulting business. "It was such a radical change from anything I had ever done before," admits Haines. And that's exactly, as Nichols had suspected, what was appealing to Haines.

For the next two years Haines drew down his bank account, and his family's patience, fiddling full-time with Nichols's ideas and eventually zeroing in on the plastic septic chamber as the most promising. If engineered correctly, the product would replace cumbersome stone-and-pipe leach fields with lightweight but high-strength polymer chambers, making it easier and faster for contractors to perform installations. Census data revealed that the market was potentially enormous.

But there lurked a major obstacle: the product would require state regulatory approval. "In the regulatory community, risk and reward mean nothing," explains Haines. "If regulators say no, they avoid trouble. We found that the way to work with them is to establish a rapport." As it happened, Nichols and Haines did much more than that. They formed--of course--a relationship.

Randy May, at the time the principal sanitary engineer at the Connecticut State Department of Environmental Protection, recalls being unimpressed when Haines first approached him about the possibility of securing regulatory approval. "I told them I had been working on ideas like that for a long time," says May. But after that initial three-hour meeting in 1985, May realized that Haines and Nichols brought a critical element to the equation: they had the engineering expertise and the business acumen he lacked. Haines and Nichols saw that May was an expert in the field, and he could explain the science of septic systems in a way that was both comprehensive and engaging.

Nichols and Haines could turn May's musings into reality; May could give Nichols and Haines instant credibility with other state regulators. There was only one thing to do: join forces. "Randy had the knowledge of the science, the technology, and the market that we didn't," says Nichols. The upshot? The duo offered May a 6% equity stake to join them, a proposal that he accepted after changing jobs to avoid a conflict of interest.

PERSUADING REGULATORS
Winning Them Over with Patience

The regulatory community would dismiss them entirely if their technical knowledge wasn't absolutely solid, May told Haines and Nichols. And so he schooled them, helping Haines gather and study reams of technical papers to support the prototype product.

Early in 1986 May met with East Coast state regulators, undeterred by their initial misgivings. "Even if they were unwilling to do what I wanted to do with the chamber, we'd continue to talk," he says. "I'd talk to them about their problems that had nothing to do with our product, try to help them out, convince them I was knowledgeable."

His presence as an advance man got regulators talking to one another, which kept the fledgling Infiltrator Systems on their radar screens. It was a slow process and one that required tremendous patience; sometimes May would return to meet with regulators several times, building relationships that gave him, and hence the product, credibility. The result? The Infiltrator received regulatory approval in Connecticut and Maine.

It's an approach Infiltrator Systems still uses. "The regulatory people know we're there to sell a product, but we don't sell right away," says Roy Moore, Infiltrator Systems' vice-president of manufacturing and national sales manager. "We try to find out what makes the program in their area tick, what their beliefs are about how septic systems work, what their problems are."

Infiltrator Systems' salespeople are trained to exercise the same type of patience. Each new employee receives one-on-one training from May, spends time in the field watching installations, travels with more experienced salespeople, and visits regulators. "We don't expect them to be effective for six months to a year," says Moore. "It's a big investment." It pays off. Infiltrator Systems' salespeople gain the kind of technical knowledge they need not only to sell products to customers but also to maintain relationships with regulators--relationships that Nichols believes will smooth the way for the introduction of new products and create a barrier of entry to competition.

GETTING MONEY
Finding Investors Who 'Understand Septic'

Nichols, Haines, and May made some early attempts to interest bankers, venture capitalists, and a potential joint-venture partner in their idea, but trying to sell septic products to the uninitiated was, well, a waste. Then Nichols, recalling the casual remark Sid Holbrook had made seven years earlier about raising money, figured out the problem: what they needed were investors who "understand septic."

So Nichols, Haines, and May devised a plan to sell seven $50,000 shares--an amount small enough to interest individuals but large enough to promise significant returns if the business panned out. The $350,000 would pay for the building of their first mold and cover expenses. Holbrook agreed to split a share with his sister, and to put Nichols, Haines, and May in touch with 2 other potential investors in the septic industry and one private investor. May brought in another investor, and Nichols took the offer to his friend Peter Matthews, an investor in a mushroom-growing business. By November 1986 Nichols and Haines had made their pitch to 11 potential local investors, about half of whom had hands-on knowledge of the septic industry. The other half were doctors, lawyers, and businesspeople willing to take a flier on the prospect of potentially huge returns.

Ten bought in, giving the partners the capital they needed to formally incorporate their new venture. It was an astute combination of smart money and dumb money, with industry people providing the credibility and knowledge that would help spread the word and also assuage the other investors' apprehensions.

"George and Jim got a lot of technical information from us and distributed it among other investors," recalls Gary Sharpe, a consulting civil engineer who split a share with his partner. "When they went to the money people, they could show them that they had knowledgeable people on-line." Matthews says that "the people who were in the contracting business were very reassuring. It was nice to know that they were aboard."

For their part, businesspeople like Matthews offered management expertise that other investors lacked. "Whenever we get into a controversial discussion, Peter does a lot of listening, and he can summarize things very succinctly," says Sharpe of Matthews.

Nichols is counting on those investors to wait longer than the typical seven-year venture-capital time frame for a return on their investments. Because he had such high expectations, he drew up a generous shareholder's agreement, giving investors two seats on the board and the right to attend every board meeting and to review all financial statements. "We wanted their continued support," says Nichols, "and their willingness to stick with it."

WINNING CUSTOMERS
Creating Demand by Building Trust

Nichols and Haines predicted sales of $1 million with a $70,000 loss for 1987, their first year in business. Instead, the company made an $80,000 profit on more than 30,000 Infiltrator chamber systems. State regulatory approval was just the first barrier; Nichols and Haines also had to create demand for their product among their customers, which include plumbing-supply wholesalers and septic-tank manufacturers.

With the help of regulators, Nichols and Haines could identify the leading septic contractors. They would then invite a contractor to install an Infiltrator system, training him on the spot while engineers, other contractors, regulators, and distributors watched. Infiltrator Systems would foot part of the bill for the system (from $650 to $850), feed the onlookers, and answer any questions. "Contractors understand making money," says Nichols. "And the huge advantage of an Infiltrator system is that you can install it in half the time."

The demo strategy was just the beginning of Infiltrator Systems' long journey toward establishing a series of interconnected, carefully nurtured relationships that would help fend off emerging competition. Distributors would meet with regulators, in some cases helping Infiltrator Systems gain local approval. And contractors, convinced that Infiltrator Systems' product was better, would approach distributors and create demand. Along the way, Nichols and Haines took care to assure distributors that they had no plans to sell their product directly to contractors. They needed distributors to support their product and eventually to take it nationwide. And the best way to win distributors' loyalty, Nichols figured, was to create relationships that transcended the traditional vendor-customer alliance.

Hence, the birth of the Infiltrator Systems "sales service representative," who would behave more like a consultant than a salesperson, helping contractors with installations and any other problems or concerns. The tactic not only would create demand for Infiltrator Systems' products but also would help distributors forge stronger relationships with contractors. "The Infiltrator reps went out with us to individuals who are now our customers and showed them the system and how to use it," recalls Kathy Herbert, vice-president at Parnell-Martin, an Atlanta plumbing-supply distributor and one of Infiltrator's largest customers.

SWAYING SUPPLIERS
Insisting on a Proprietary Relationship

In 1990 Nichols and Haines--characteristically ignoring the fashionable trend of "outsourcing" then spreading among their entrepreneurial peers--decided to build their own manufacturing plant. About half of the $5.2-million price tag would go for a proprietary machine to be built by Johnson Controls, a $10-billion maker of building-systems controls and plastics machinery. More specifically, the two were counting on Ed Hunerberg, now director of the structural-foam-technology division of Johnson Controls. Nichols and Hunerberg had known each other for 20 years; Hunerberg had actually hired Nichols as a consultant back in the early days of Infiltrator Systems. Five years after that consulting stint, when Nichols asked Hunerberg to manufacture the custom machinery, Hunerberg was willing to "go to our vice-president and convince him that it was a good deal. We were taking a risk," he says, "because the machinery was specialized for Infiltrator, and it would have been difficult to sell it on the open market if the company had not been able to make final payment."

Hunerberg's faith in Nichols and vice-president of manufacturing Moore clinched that first deal. Since then, Johnson has built four more machines for Infiltrator Systems. Hunerberg, Nichols, and Moore meet twice a year with Infiltrator's machine operators, maintenance people, and the folks at Johnson who actually build the machines, for "continuous-technology-improvement meetings," says Hunerberg. They're tire-kicking sessions that typically lead to the kind of project Hunerberg is currently working on for Infiltrator Systems--a state-of-the-art machine that will give Johnson the opportunity to test a new technology. "A lot of customers would say, 'We don't want to be the first ones," says Hunerberg. "But Jim and Roy are willing to stick their necks out." In addition, Johnson has granted Infiltrator Systems exclusive rights to the technology in their market. "We've never given anyone exclusive rights to our technology," says Hunerberg. "But it was important for Jim to have that proprietary position. We felt we were going to hang on to his star."

THE PAYOFF
State of the Unions

Infiltrator systems racked up sales of about $50 million in 1996, and Nichols predicts $70 million for 1997. But even the embrace of so many relationships can't shield Infiltrator Systems from rough spots. The price of plastic resin increased last year, taking a painful bite out of profits. And for the first time, Infiltrator Systems had difficulty keeping up with demand; deliveries were late. Then there are the shareholders, some of whom are pressing for a return on their 10-year investment. But because Nichols and Haines have cultivated such solid relationships, the bumps are easier for everyone to take. Banker Dean Ryan, for instance, understood the effect resin prices could have on the company long before he saw it reflected in the numbers. Customer Kathy Herbert admits that deliveries have been "nip and tuck sometimes," but she knows that "all companies go through production problems, and we have never had Infiltrator not take care of us."

And the shareholders? Nichols admits he must pacify them. To finance Infiltrator Systems' growth, he's raising about $13.5 million through mezzanine financing obtained from new investors, and he'll earmark about $3.4 million to buy back some shares. "No one is going to sell out entirely," says Nichols, who estimates that each initial $50,000 investment is now worth $1.4 million. "And a couple of people aren't selling anything." They're waiting for the ultimate payoff--the initial public offering that Nichols is planning anywhere from two to five years out.

To do that, he knows the kind of investor he needs. He's after "someone who understands our story and has bought into what we're doing, who has knowledge of the IPO market, who has business acumen, and who can make a contribution to the board." Neil Powell, chairman of SPP Hambro & Co., the New York City­based investment-banking firm that's handling Infiltrator Systems' search for mezzanine money, clearly understands Nichols's mind-set. "He's looking for a relationship with someone who's willing to help the company not just at this stage but well into the future," he says.

Nichols has also made contact with a major investment-banking firm. He's been talking to people there for more than a year, sharing information about Infiltrator Systems, learning about the IPO market, building a--well, you know. "Most companies wouldn't bother to spend the time educating someone about their business this far from an offering," says a managing director who declined to be identified. "But this way we have a chance to see what they can do over a period of years, and they get to know us and look at us as a source of advice."

Having proved himself a reliable source of advice, that managing director will have a competitive advantage when it comes time for Infiltrator to choose an underwriter; meanwhile, Nichols gets an education. Probably, each walks away thinking he's getting the better end of the deal. It's a common scenario for Nichols--a strategy characterized by a long-term investment of time and energy, applied with equal intensity to ditch diggers and investment bankers, with the expectation of mutual reward. And like all good missionary work, it's perpetuated by the converted. "This could be a wonderful public company," says the investment banker, who rattles off some facts about proprietary technology and market share. He's excited. About septic systems. Jim Nichols doesn't ask for more--not yet, anyway. The relationship, he knows, is just beginning.

The Partnership Track

When Jim Nichols talks about "relationships," he's not just stamping a new-age word on the fine old art of schmoozing. Nichols applies some very exacting standards to his partnerships. Such as--

Stand by your partner. In Infiltrator Systems' early days, plastic resin (the main component of the company's product) was tough to come by, so suppliers put their existing customers on allotment and rarely took on new ones. Undeterred, Nichols went to Union Carbide with his business plan and, in exchange for an allotment, pledged his loyalty to the company when the market loosened up. It worked.

Look beyond titles and status. When Nichols and George Haines were interviewing public accounting firms two years ago, they were particularly impressed with one member of Peat Marwick's team, Roy Filkoff. "He had global vision," recalls Nichols. Any number of senior partners might have been assigned the Infiltrator Systems account, but Nichols and Haines insisted on the more junior Filkoff. He's now the company's chief financial officer.

Don't pigeonhole. Roy Moore knew plastics manufacturing inside and out, but no one would have mistaken him for a salesperson. Except maybe Nichols, who met Moore through an industry contact in Atlanta. When Nichols approached Moore about selling Infiltrator systems in the Southeast, Moore was initially taken aback. "I had never sold anything in my life," he says. Georgia is now Infiltrator Systems' largest market.

Understand the power of company lore. "When we were first approached to take on the Infiltrator line, I thought it was crazy, because it just wasn't a typical product for our company," recalls Kathy Herbert, vice-president at Parnell-Martin, a plumbing-supply distributor in Atlanta. "But the people--Roy Moore and zone manager David Click--they had a story to tell." Herbert was so intrigued with the tale that she even helped Infiltrator Systems gain local regulatory approval.

Last updated: Jan 1, 1997

DONNA FENN is the author of Upstarts! How Gen-Y Entrepreneurs Are Rocking the World of Business and 8 Ways You Can Profit From Their Success, an exploration of the ways Gen Y is changing the entrepreneurial landscape.
@donnafenn




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