Climbing Back Up
When the founders of X-It Products saw a billion-dollar rival imitate the design of their popular new fire-escape ladder, they didn't have much hope that their tiny start-up could survive. Amazingly, it has.
Andrew Ive couldn't sleep one night in his dorm at Harvard Business School. The smoke alarms were blaring again. Ive assumed that the alarm was triggered by a fellow student's microwave popcorn or perhaps another's cigarettes. But what if -- heaven forbid -- there was an actual fire?
The next day Ive went to a local store, bought a fire-escape ladder, and tested whether it could support his then-215-pound frame. Watching the rehearsal was classmate Kevin Dodge. "Andrew was hanging out of the second story, and the ladder broke," Dodge recalls. Ive's feet went right through the top rung, forcing him to hang on to the windowsill until someone pulled him inside. It was the fall of 1996, and Ive had found his project for Professor Marco Iansiti's product-development class.
But he needed someone to build it. One of his best friends at HBS, Aldo DiBelardino, had an engineering background and was also in Iansiti's class. While DiBelardino built a new and improved ladder, Ive polished what would become X-It Products' business plan. The plan stated X-It's intention to "set the quality standard" in the $3.4-billion fire-protection market. Among the hypothetical exit strategies for the business: an acquisition by market leader Kidde Safety, a U.S. division of billion-dollar Kidde PLC in England.
Less than three years later X-It was a real company with a hot new product, and Kidde was indeed trying to acquire it. But that's where the fairy tale ends.
X-It's future was looking bright right up until the 1999 National Hardware Show in Chicago's McCormick Place. It was X-It's second year at the industry's megashow, at which some 3,000 companies display their wares to the Wal-Marts and Home Depots of the world. Already, thanks to the ladder's light weight and extreme compactness -- it collapses to nearly the size of a shoebox -- X-It had cracked the Southwest region of Home Depot and also was selling ladders through Amway and Kmart.
X-It and Kidde had already had two exploratory meetings and had arranged to get together on the second day of the show. On the show's first day, Ive, who was by then X-It's CEO, dropped by the Kidde booth to say hello to his potential new partners. He was stunned by what he saw: Kidde was displaying a ladder almost identical to X-It's. Kidde's packaging even appeared to be the same, right down to the photograph on Kidde's box that showed DiBelardino's nephew and sister-in-law using an escape ladder. To make matters worse, says Ive, a Kidde rep was showing the ladder to a buyer from Wal-Mart. In disbelief, Ive entered Kidde's exhibit booth and approached Kidde Safety president Michael Apperson. Apperson, says Ive, took him by the arm "and basically escorted me off the stand and said, 'I'll talk to you tomorrow.' "
On the second day of the show Ive stopped by the Kidde booth for his scheduled discussion with Apperson. Ive complained bitterly that Kidde's ladder infringed on X-It's intellectual-property rights. Apperson disagreed with Ive's protest on the grounds that X-It's patent was still pending. As for the picture on the box, Ive says, Apperson told him, "You don't own that photograph. It's probably some stock photo." Ive countered that the subjects were DiBelardino's relatives. Kidde employees later blotted out the offending images with black marker.
In the weeks following the show, Ive says, his independent sales reps -- who were in discussions with Wal-Mart, Target, and Home Depot's other regional buyers -- stopped returning his calls. Ive's theory: "These salespeople all work on commission. And what they saw was the market leader coming out with an identical product." Fearing that their start-up would die if they just did nothing, DiBelardino and Ive soon decided to sue Kidde for copyright infringement, misappropriation of trade secrets, and six other counts of business misconduct.
That was in late 1999. It would take until August 2001 for the trial to conclude. Those two years would be a harrowing period for X-It. In 2000 sales would slump 31%, to $248,000, and the company would lose $400,000. Its total legal bills would surpass $3 million. But despite setbacks that might have done in many a company, X-It would manage to stay alive -- partly because of the deep pockets of its Harvard connections and partly because of an entrepreneurial scrappiness that belies the company's crimson pedigree.
X-It's story is striking for other reasons. The company was founded by top-of-the-line business-school students. Its product had gotten great publicity, with mentions on national television and in a profile in Inc (July 1999). It was backed by an all-star group of affluent, plugged-in Harvard professors and alums. It took reasonable legal precautions. Yet in spite of those strengths, it was unable to prevent a much larger competitor from jumping into the market with an almost-identical product. If that could happen to X-It, could it happen to any entrepreneur with a nifty new concept? And if so, what does that mean for American innovation? To the folks at X-It, those are some of the broader implications of their case against Kidde Safety.
Mind you, they are not the only ones using the fate of capitalism as a rallying cry. In closing arguments at the trial, Kidde's lawyer maintained that X-It's legal assault was nothing more than an attempt to cover up its own inability to thrive in a free and open market. "What happened here was competition, surely. You might even think it was hard-nosed," says Laura Luger, Kidde's attorney. "But that is the American way."
Shaken to the core by what he had seen at the Chicago trade show, Ive did what any fledgling CEO faced with a crisis would do: he called his financial backers to let them know that the company now faced a serious competitive threat. Since Ive launched the company, in 1997, his eight angels had provided not just financial backing but emotional and management support as well. Now he needed their counsel more than ever.
One of X-It's investors was a British businessman named Charles Sinclair, who had lots of connections in London. Sinclair happened to know Nigel Rudd, chairman of the conglomerate that at the time owned Kidde PLC, and he agreed to write Rudd a letter seeking to discuss what had happened at the trade show. Sinclair's letter led to his meeting with Michael Harper, CEO of Kidde PLC, and another X-It investor and HBS alum named David Dutton. Describing the meeting later in a deposition, Harper said, "I relayed to Mr. Dutton and Mr. Sinclair that there had been a regrettable lapse of judgment in the presentation of one prototype box at the Hardware Show in August of 1999."
Harper also reiterated Kidde's desire to own the X-It ladder, says Dutton. "His position was that X-It was not a company, it was an invention, and that any recompense we might receive would be on that basis," Dutton recalls. Before the trade-show episode, Kidde had mentioned a figure of $600,000 plus a $2-per-ladder royalty. Ive, who had asked for $16 million as an opening bid, had taken the number to his investors before responding with a firm no-thank-you. "I expected them [Kidde] to come back with a different number," says Ive. "But they didn't."
Whatever the reason for Kidde's change of heart (its executives declined to talk to Inc for this story), its contention that X-It wasn't much of a company had some merit. The "staff" had consisted, for the most part, of Ive and DiBelardino, with the former concentrating his attention on sales, marketing, and general management from his home office in Manhattan, and the latter focusing on shipping and manufacturing from his outpost in Virginia, where he lived with his wife and two children. The two entrepreneurs had heartily embraced the concept of a "virtual company." They had outsourced their manufacturing to a factory in China, and after landing their first few accounts with catalogs and home-products distributors, they had handed over the sales function to independent reps. Distribution? Well, that was where UPS came in. It all seemed so simple -- and already someone was knocking on their door to discuss the prospect of cashing them out!
But as the company's dream acquisition began to unravel and the prospect of a competitive new product sold by an 800-pound gorilla became more real, the frailty of their business became increasingly apparent. As new pressure bore down on the two partners, they began finding fault with each other's work. DiBelardino blamed Ive for the collapse in sales, which left the company with only about $20,000 in cash. Ive, meanwhile, thought DiBelardino should have done more to reduce the company's exorbitant manufacturing and shipping costs. The two began E-mailing potshots at each other and rarely failed to "cc:" Dutton, Sinclair, or other key investors on their mudslinging.
Whether it was Kidde's entry into the marketplace that was at the root of X-It's problems -- or simply X-It's own shortcomings -- is hard to determine. The result, however, was clear: a serious cash crunch was in the making. To ship a container of 4,000 ladders from China to the United States cost $60,000, which X-It had been paying with advance orders from stores like Home Depot and home-products catalogs. When those orders didn't materialize, X-It left the customers it did have stranded. Hundreds of customers who had ordered X-It ladders through SkyMall catalogs, which are stuffed into the back of airline seats, complained about delivery delays. Chuck Hohmann, director of inventory at HSN/Improvements, the company that produces the SkyMall catalogs, recalls: "I had the impression we were never going to get the product. It seemed like they'd gone out of business, but they hadn't let anybody know."
As the financial strains on the company grew, Ive and DiBelardino tried to put their differences aside. Ive frantically began trying to drum up new sales, while DiBelardino decided to focus on finding a law firm that would somehow be willing to go after a billion-dollar company for a hundred-dollar client. And he started laying the groundwork for a "fighting fund" that Dutton had suggested he create to float the company as it recovered from the hardware show and prepared to do battle in court.
The company's deteriorating financial position and the tension between the founders were at the top of the agenda at a key meeting with investors on November 8, 1999. Before the meeting, Dutton, who by now had taken the lead among the investors, sent DiBelardino and Ive a stinging E-mail. The message stated that "management has failed" and cited, among other issues, production and supply problems and immature behavior that Dutton likened to that of "two pre-teenage children." Ive says the letter made him feel "like being told off by your dad."
DiBelardino and Ive came to the meeting armed with separate proposals for how to take the company forward. Ive decided that the only way X-It could capture new business would be to invest in infrastructure -- extensive customer service, an office that would end the founders' long-distance isolation -- that would make X-It look more like a company than an invention. DiBelardino's plan was almost the opposite: he wanted to drastically slash costs and halt new-product introductions.
The board ultimately chose DiBelardino's plan, which also included Ive's departure. The investors restructured the company's equity, reducing Ive's stake from 27% to 10%, and negotiated a transition of power that would culminate in Ive's exit by the spring of 2000. For the next five months after that, the two friends barely spoke to each other.
As X-It's new CEO, DiBelardino had to act fast. His first order of business was to straighten things out with important customers like Hohmann. But to send Hohmann more ladders, X-It needed money to order them from China. And in the spring of 2000, that money was nowhere to be found.
DiBelardino approached Dutton and another X-It investor, Howard Stevenson, an HBS professor, asking them to make him a series of short-term $10,000 loans. His main aim, of course, was to get the cash. But his ulterior motive was to recapture the faith of X-It's investors. He knew he'd need them for his court battle. And he hoped he'd be able to leverage their reputations in order to lure other investors into the "fighting fund" as well as to persuade a law firm to take his case.
First, though, he needed to sell some ladders to pay back the loans. Even with angel assistance, he was still short of the $60,000 he needed to ship a container across the Pacific. However, DiBelardino had a great rapport with the owner of the Chinese factory, dating back to the time he and Ive had visited the assembly line and, after a particularly long night, ended up sleeping there. He called to explain his situation and got 60 days of credit at 10% interest.
As sales from HSN/Improvements began rolling again, DiBelardino used Hohmann's first payment to pay Dutton and Stevenson. To buttress his position with them, DiBelardino also promised to meet several cost-cutting goals. He agreed to reduce X-It's burn rate to $9,000 a month from its peak of $25,000 a month. By doing that, he hoped to show that their money would be strictly for legal fees, not to prop up a company recovering from poor management.
Luckily for DiBelardino, many of X-It's costs went out the door when Ive left. Suddenly, there was one less salary and no Manhattan rent to be paid, and the phone bill was significantly lower. DiBelardino ended a monthly retainer for a public-relations firm that Ive had hired. But his most significant cost reduction came from switching X-It's warehouse facility from one in Los Angeles, where X-It had been paying for unionized labor and space, to a makeshift space just off the Chesapeake Bay.
Thanks to a tip from a college pal, DiBelardino contacted the manager of the local Farm Fresh grocery store, who agreed to let him use spare space in the store's warehouse, which was only five miles from a Chesapeake port. In the warehouse DiBelardino hung a blue tarp from the ceiling, cordoning off X-It's section from the dollies, forklift, and pallets on the Farm Fresh side. Behind the tarp DiBelardino set up a desk with a used computer he had bought for $300. The warehouse saved him more than $1,000 a month in rent and about that much in shipping costs.
DiBelardino also used his hometown connections to score some low-cost labor. Now, whenever a container arrived, he recruited a group of teenage boys he knew from his church to help transport the ladders from the loading dock into the warehouse. He paid the boys $9 an hour, scheduled time on the Farm Fresh forklift, operated the forklift himself, and provided pizza and music.
So there he was, using the community as a low-cost resource, assuming one obligation to offset another, working a forklift, and locating in a warehouse. The Harvard student had become a dyed-in-the-wool entrepreneur.
By early summer 2000, DiBelardino had settled on the Norfolk office of the law firm Hunton & Williams to handle X-It's case. The firm initially estimated that the case would cost at least $300,000, and on July 10, 2000, X-It filed its suit. Over the next 12 months, X-It and Kidde filed numerous motions and cross motions, each one consuming a boatload of billable hours. That made DiBelardino's fighting fund critical. But to persuade X-It's angels to contribute to it, DiBelardino had to overcome not just the company's tangible losses but skepticism about whether he would ever win his case. In all, four of X-It's original eight angels opted not to participate. For Dutton, though, contributing to the fighting fund was a no-brainer compared with his initial decision to invest. "In my opinion -- and I said this to Harper -- the acts of Kidde were out of order," he says. That Kidde might get away with its behavior because X-It lacked the funds to fight back was "something I don't find easy to live with," he says. Joining Dutton as the fighting fund's ethical flag bearer was investor Howard Stevenson, whose sense of outrage equaled Dutton's. Dutton kicked in more than $100,000, while Stevenson contributed $50,000. In the end, DiBelardino raised a total of $272,000.
To make the fund stretch as far as possible, DiBelardino worked hard to minimize billable expenses. When his lawyers needed to travel to Mebane, N.C., to depose key Kidde employees, DiBelardino borrowed his mother's more reliable car and drove his lawyers down. The road trips also gave the lawyers a chance to interview DiBelardino -- something that otherwise might have meant an additional office visit at high hourly fees.
In April, with the case having dragged on for nine months, both parties in the legal dispute asked the judge to rule summarily on some or all of the counts. The judge ruled for X-It on the issue of copyright infringement at the 1999 show. On other matters, such as whether X-It's customer list was a trade secret, the judge ruled for Kidde. Most of the issues relating to the sanctity of X-It's pending patent the judge left for the jury to decide.
In July 2001 the trial finally began. DiBelardino had been anxious for that day to arrive. "I'd been deposed five times, my parents had been deposed, they'd gone up to Harvard and UVA to get my transcripts. It was inconvenient and torturous at times," he recalls.
During the trial, X-It's lawyers established that Kidde had become interested in X-It's new ladder after seeing it at the 1998 trade show. Kidde's Carl Tomeo, then director of materials, ordered several X-It ladders over the Internet and had one shipped to his Chinese manufacturer with instructions to replicate it. When Harper was shown photos of the two companies' products during his deposition, he was unable to tell which ladder and packaging came from which company.
From the trial's opening bell, Kidde's position was that even if the two products were very similar, there was no evidence that it had resulted in any harm to X-It. And indeed, X-It was unable to get any major retailer to testify that it had decided against ordering X-It ladders because of Kidde's product. "The competition was tough on both sides, and there were mistakes made on both sides," said Kidde attorney Luger in her opening statement. "But the evidence will also show that Kidde never, never set out with an improper intent to harm or injure X-It. Nor is there any evidence of ill will. The deal didn't happen. There was disappointment, and there was anger. The evidence will show that rather than battle it out in the retail business world the hard way -- through marketing, selling, product supply and fulfillment, and customer service -- X-It in this lawsuit is attempting to claim the profits it never could have earned itself."
During the four-week trial, an interesting development emerged in X-It's arguments. The company's lawyers introduced a deposition given by Apperson, who by then was no longer president of Kidde Safety, acknowledging that more than 16,000 of Kidde's ladders had straps and webbing made from polypropylene, a flammable material. Additionally, X-It's lawyers established that some Kidde ladder hooks had been coated with lead-based paint. Kidde vigorously denied that its use of either material resulted in any safety problems, saying that X-It was trying to hold it to standards that weren't relevant. But because Kidde had been selling its products in packaging that was modeled on X-It's and therefore carried the words "flame-resistant" and the "safest," the charges supported X-It's claim of false advertising. By the time the trial began, however, Kidde had removed any polypropylene from its ladders and had reduced the lead content of its paint, citing a constant effort to improve its products.
Apperson did not return repeated messages left for him at American Fibers & Yarns, where he is now CEO. Harper, who also did not appear at the trial, refused to comment on any matter related to the X-It trial. Apperson's replacement, Ed LeBlanc, also did not appear at the trial and told Inc he was not able to answer any questions, pending resolution of the lawsuit. But twice last year he contacted Dutton in London, according to Dutton. On both occasions -- the first a phone conversation and the second in person at dinner -- Dutton says, LeBlanc told him that X-It "didn't have a case." The two talked settlement, but the negotiations always hit a snag. "We dodged around the issue because we were miles apart in terms of what we could agree on," says Dutton.
The jury clearly felt that X-It did have a case. On August 17, 2001, it awarded X-It more than $21 million in compensatory damages and $95 million in punitive damages, finding Kidde liable on all six remaining counts. DiBelardino was not only happy with the verdict but relieved that the trial had ended. "By the time the fourth week had begun, I just wanted to get out," he says. He adds that he was "humbled and overwhelmed" by how, to his eyes, the jury's attention span never seemed to flag.
The $116-million award is subject to judicial review. Both sides expect a reduction, given that the punitive damages exceed Virginia state limits. On December 17, the judge heard arguments from both sides about whether X-It's award should be reduced and, if so, by how much. Kidde asked the judge to reduce the compensatory damages to $842,556 (X-It's expert's calculation of Kidde's profit from selling the ladders) and slice punitive damages to $350,000, the Virginia limit. As of press time, in late January, the judge had yet to announce a decision. He did, however, issue a permanent injunction giving Kidde 40 days to recall all packaging, photographs, or artwork that was "substantially similar to or derivative of X-It's copyrighted material."
Kidde, of course, may decide to appeal. And when the case finally ends, X-It may still find itself competing against a Kidde product that, while legal, amounts to a knockoff. Still, the verdict gave DiBelardino some pleasure. The outcome -- tentative though it might be -- has given him more confidence that he'll be able to pay his legal fees. The verdict also gave him a reason to call all 30 of his accounts to thank them for their ongoing support. Thanks to those relationships, X-It's sales rose 23% last year, to $320,000.
And to some extent, the award has restored some calm to DiBelardino's personal life. The trial had caused him to, as he put it, "fall off the wagon" in terms of family obligations. He'd lost many a weekend driving down to North Carolina or working on X-It matters. On many occasions, he got the "you need to get home earlier" speech from his wife.
But those days, he believes, fingers crossed, have passed. At the very least, he can see the day they will end. "I think we've gone over the highest crest, gone past the lowest low, and hopefully we're toward the conclusion of the ride," he says.
Ilan Mochari is a staff writer at Inc.
Please E-mail your comments to firstname.lastname@example.org.