RULE #5: Come up with an overhead absorber.
I'm talking here about a product that's going to meet the customer's need and that you can begin selling immediately. After all, as soon as you start the business, you're going to have overhead expenses: salaries, rent, electricity, telephones, and so on. You need to be producing something you can use to cover those expenses -- or absorb them, as we say in manufacturing. In the case of Engines Plus, the overhead absorber was the line of remanufactured oil coolers.
Once you put together a cash-flow generator and an overhead absorber, you have the most important thing a start-up needs: positive cash flow. As a result, the business is immediately viable, meaning that it can support itself on the cash it's generating internally. It doesn't have to rely on outside sources of capital to stay afloat.
RULE #6: Diversify, diversify, diversify.
Becoming viable, however, is just the beginning. You haven't maximized the value of your business as long as its cash flow comes from one product and one customer. Hence the next step: diversification. You need to be constantly looking for vulnerabilities you can address and opportunities you can capitalize on. In other words, you need to innovate, coming up with new products and services, new markets, maybe even new businesses, as you work on optimizing the ones you already have.
That was the basic formula, and it worked better than we dared to hope. Paulsen loved the plan and signed up immediately. We sold him 25% of the stock and agreed to a valuation formula that rewarded him for increasing the company's assets or reducing its liabilities, thereby giving him a powerful incentive to watch every nickel.
And he did. Indeed, Paulsen displayed many of the bootstrapping qualities I thought we were in danger of losing at SRC. He was resourceful. He was creative. He did all the clever little things you do when you're getting by on pocket change and know you're doomed if you run out of cash.
The business couldn't get going, for example, until the shop had worktables. So Paulsen and his buddies found some heavy crates used to ship engines. They cut out the saddle for the engine, came up with square metal tubes to use as legs, and added a top, and they were in business.
Then there was the oven needed to dry the rebuilt coolers before checking them for leaks. Industrial drying equipment could cost as much as $10,000. But Paulsen had worked in restaurants as a kid. He decided to look up a company that sold used restaurant supplies. There he found a pizza oven with just the right specifications. He bought the oven for $200.
That's what innovation is all about. It isn't glamorous, and it doesn't take place in corporate offices. It happens in cellars and garages and makeshift workrooms, and it mainly involves a lot of hard work. But the results can change lives.
Bit by bit, the pieces came together. It happened so fast we could hardly believe it. In February 1988, its third month in existence, Engines Plus shipped 350 to 400 rebuilt oil coolers to SRC. I'd spent two years trying to get our people at SRC to focus on developing a process for remanufacturing oil coolers. Paulsen and his people had come up with one in a matter of months. By the time the bugs had been worked out, moreover, they were able to remanufacture those oil coolers for a small fraction of what we'd been paying. SRC took them all -- and saved a lot of money.
We'd innovated our way out of one problem, but with one product and one customer, Engines Plus had barely begun to tap its potential market value. So Paulsen quickly moved on to the next step of the program, marketing automotive engines by direct mail. Within a year, however, a much bigger opportunity presented itself.
One of our major customers, known as J.I. Case back then, had a joint venture with Cummins Engine Co., under which the two companies manufactured and sold a couple of powerful engines used in agricultural equipment. Looking for opportunities to sell more engines, Case's president of parts operations, Robert Nardelli (now CEO of the Home Depot Inc.), came up with the idea of incorporating the engines into a new line of stationary power units, which farmers would use to pump water for irrigation. He inquired whether SRC would be interested in manufacturing the power units as a subcontractor to Case.
It was a nice offer, but it didn't really fit in with our main businesses. So we put the Case people in touch with Paulsen, who signed up on the spot. After looking at some power units made by other companies, he put together a quote, which the Case people accepted. They came back with a design of the unit they wanted. "Can you do it?" they asked.
"Sure," he said.
There was just one problem. He knew nothing about making power units. The Case people wanted him to exhibit a prototype based on their design at their big annual trade fair in Kansas City on November 1, 1989. Although Paulsen and his people had never built a prototype before, they somehow managed to pull one together in time. A couple of them stayed up the whole night before the trade fair, drying the paint with handheld hair dryers. When Paulsen returned from Kansas City three days later, he had orders for 200 power units, which Case would buy from him for $5,000 each -- $1 million in sales of a product that had never been tested, that he wasn't even sure would work.
