The Innovator's Rule Book

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It was one of those classic entrepreneurial situations. Even if the product passed muster, Paulsen didn't have a factory large enough to make the power units. For that matter, he didn't have the necessary machine tools, workforce, or raw materials. Worst of all, he didn't begin to have enough cash to finance the power-unit business -- either then or in the future. If Case bought as many units as expected, Engines Plus's sales could grow from less than $1 million to more than $11 million in three years. Where would the cash come from to pay for that growth?

The answer, it turned out, was Case.

When we sat down to negotiate with the Case people, we proposed a deal under which Case would pay Engines Plus for the power units in 30 days, and Engines Plus would pay Case for the engines in 90 days. (Remember, short receivables, long payables.) That way, Case would get what it wanted: the opportunity to record the sale of the engines as soon as they were shipped. And Engines Plus would get what it had to have: net positive cash flow for 60 days.

That was, in fact, the arrangement we agreed upon, and it allowed Engines Plus to develop the power units. At a production level of 66 units a month, the 60-day lag time was like getting an interest-free loan of $660,000 for the entire length of the contract. As a result, Engines Plus -- which had already paid off its note to SRC -- was able to grow for the next seven years without taking on any significant bank debt, and Case got a lower price, since there was no interest expense in the power unit's cost.

I guess you could call that an innovation as well.

If you sell a pen, you can make a dollar. If you sell a pen company, you can make $10 million. When you play the game of business at the highest level, you understand that the company is your product, not the pen.

The case deal was a turning point not only for Engines Plus but for SRC. It had always been our intention to sell Engines Plus to SRC at a bargain price if the start-up proved successful, so that the employees who own our company would reap the major rewards. On February 1, 1990, all the Engines Plus shareholders except Paulsen sold our stock to SRC, which -- for $24,000 -- acquired a 75% ownership stake in Engines Plus.

But the stock transfer was only the beginning -- because Engines Plus had clearly changed. It was no longer simply an experiment in innovation, nor even just a way for SRC to save money on oil coolers. With the Case deal, Engines Plus had become a real business, capable of generating a significant amount of cash flow from a mix of products and a mix of customers, both of which could be expanded in the future.

That change had enormous implications. To begin with, it meant that Engines Plus could be sold. We probably could have found a buyer right away if we'd had to. We would certainly be able to find one in the future if we did a halfway decent job of developing the business. By then the company might be worth a lot of money. It was by no means inconceivable that, in a few years, SRC could sell its stake for several million dollars.

That could prove critical if SRC wanted to remain privately held. As an employee-owned company, we were going to need a lot of cash in the future to cover our obligations to departing shareholders while we continued to grow the business. Engines Plus could be a significant part of the solution. (Last year, in fact, we received an offer from an outside investment group to acquire Engines Plus for $13 million. The terms weren't right, and so we didn't do the deal. Still, that wouldn't have been a bad return on a $1,000 investment.)

And if we'd had one successful start-up, why couldn't we have others? Why couldn't we keep right on building businesses that we could use to feed the liquidity of the parent company? Businesses that we could sell, if necessary. Businesses with higher gross margins and better cash flow than remanufacturing had. Businesses that would grow when our traditional markets were contracting. Businesses that would open up new opportunities when we'd reached the limits of optimization with the old ones.

The realization hit me like a thunderbolt. That was it! We had a model we could use to build whatever kind of company we wanted -- which was yet another innovation to come out of the Engines Plus experiment.

In fact, the success of Engines Plus changed the whole way we thought about growing the company. You need only look at SRC today to see the effect. Back in 1987, we were one business with two divisions. Now we are a diversified collection of enterprises and an ongoing business incubator.

Altogether there are 22 companies operating under the umbrella of SRC Holdings Corp. Some, like Engines Plus, are direct spin-offs of our engine-remanufacturing business, meaning that we started them to leverage expertise we already had. But we've also ventured outside remanufacturing to apply our ideas to other types of businesses.

Feeling the urge to spread our wings, we started a bank with a group of local investors a few years ago, partly because we thought it was a good investment but also because we wanted to see how our approach to management would work in an entirely different setting. In fact, the bank has been a phenomenal success, consistently outperforming most midwestern banks of its size in terms of return on equity, total assets, operating efficiencies, and just about every other measure.

More recently, we raised $6 million to launch a venture-capital firm, which operates out of our headquarters. Our goal there is simply to earn a better return on our capital. To date, we've invested in seven start-ups, three of which have gone public.

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Bo Burlingham

Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants: Companies That Choose to Be Great Instead of Big. The book was a finalist for the Financial Times/Goldman Sachs Business Book of the Year Award in 2006. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business and A Stake in the Outcome.

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