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STRATEGY

Case Study: The Offer You Almost Can't Refuse
 

A woman from Target is on the line. She wants your product, but you'll have to completely change your company to get the deal. Do you dare to say no?
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Case Study

Louis J. Stack felt it in his gut. His company, Fitter International Inc., was well primed to enter the mass market. Based in Calgary, the business had a reputation as a trendsetter in a lucrative niche -- selling expensive balance-related fitness equipment to physical therapists and athletic trainers. "Things started in my basement 17 years ago after I had knee surgery and double foot surgery," says the former speed skier and luge racer. The business had grown nicely, first earning a profit in 1995 and reaching revenue of $3 million in 2001.

Early in 2001, Stack's ambitions to take his products mainstream began to blossom. He saw Reebok and Nike start to develop balance products of their own. He also detected more interest in his high-priced wares among specialty outdoor and sports retailers, which accounted for 10% of his sales. Then, at a trade show that spring, a scout working for Target approached Stack's tiny, poorly situated booth. "She said she had looked at other companies that do what we do, had asked around about us, and had discovered that we were the real deal," recalls Stack. An hour and a half later, the CEO had an irresistible offer: come to Target's headquarters in Minneapolis to discuss a possible vendor relationship. "I was so pumped up, I felt lighter on my feet," he says.

Four months later Stack strolled into Target's offices wearing his best Fitter golf shirt and khakis. The pitch he made that day was simple: aging, affluent baby boomers constituted a large and growing market for his products. "Why does the average Joe have to wait to get injured to buy from us?" Stack asked the Target reps rhetorically. "Let's go after them before they're hurt."

Stack then showed his audience Fitter's "wobble board" -- a $60 slab of wood mounted on a spherical base -- as well as a balance ball and a sitting disc to be used atop a standard office chair. At the end of the meeting, the Target buyers told Stack they were very interested. But there was a but. He would have to slash his prices in half and create a branded line of three complementary products in order to get the deal.

On the flight home, Stack did what he does best: he mulled. If he was going to go for it, he would need to revamp his entire business. His franchise product would have to undergo a makeover. The company would need to design and build a new, lower-cost injection-molded wobble board while remaining true to its existing patents. That would require hiring a product-design engineer and spending more on research and development. And since Stack's existing contract manufacturer worked only with wood, he'd also need to find a new company to produce the plastic boards. Next Stack would have to cajole his German supplier of sitting discs into giving him better pricing in exchange for higher volume. And he'd have to find a new supplier of fitness balls, since the high-performance balls from his current source were far too expensive for Target.

The Fitter organization would have to change, too. Stack had already been considering moving his operation to a larger building, but Target's business would make that a must. He also figured he'd have to add another 8 to 10 people to his staff of 18. Stack knew those changes would cost a fair amount of money -- at least $80,000 to redesign the wobble board, $175,000 for leasehold improvements on a new building, and $60,000 for new packaging and marketing.

The looming financial outlay kept Stack from jumping at the Target offer. The entrepreneur was passionate about his company -- and passionately possessive. He couldn't imagine relinquishing equity in Fitter. "I was functionally bankrupt for 14 years, and we had just started to see the negative numbers on the balance sheet go away," he explains. The good news was that new, lower-cost suppliers and higher-volume business could ultimately reduce the cost of his goods sold by a dramatic 40%. "As long as we can keep our ratios in line, we can get debt financing," he reckoned.

Perhaps most significantly, Stack worried about cannibalizing the brand he had worked 17 years to create. At a minimum, he would have to take steps to differentiate the existing professional line that was sold by his catalog and medical dealers from the new, lower-priced retail line. At the same time, Stack's retail-price-point strategy would be driven solely by Target's demands. However, he could hawk his new line to specialty retailers as well. Was the price right for that market, too? Reebok's core board was selling for $190, and Nike's new balance product was set to sell at $79. Could Stack compete with them with a lower-priced product aimed at office workers rather than fitness enthusiasts?

And what about the particulars of working with a big-box retailer like Target? Would the company demand long terms, which could wreak havoc with Stack's healthy cash flow? Could he keep up with increased demand for his products? "I didn't want to be overwhelmed," he now says. "Moving too fast scares me." But for a former athlete, moving too slowly was scarier still. "We could lose the leader position," he fretted. A tremendous opportunity was being laid at his feet, but Stack would have to reinvent his company to take advantage of it. "The steps I'd need to take to achieve the outcome I wanted were monumental," he recalls.


The Decision

"If I don't do this, then someone else will," rationalized Stack. Late in the summer of 2001 he began making massive changes to his company. He developed a new injection-molded wobble board, signed on a new local contract manufacturer, secured a $100,000 loan, and had his credit line bumped up from $150,000 to $225,000 by the Royal Bank of Canada. He hired 10 people, including managers for purchasing, shipping, and operations, plus 4 salespeople. To equip and furnish his new 12,000-square-foot building, Stack, ever frugal, shopped at bankruptcy auctions, where he bought everything from a forklift to picture frames for 15 cents on the dollar. He found new suppliers of fitness balls and sitting discs at the right price point.

Then, a setback. The buyer from Target left her job, leaving Stack twisting in the wind. Instead of going back to Target immediately, Stack decided to focus heavily on specialty-store clients, enticing them with higher margins on his new, lower-priced line of products. Fitter was suddenly on the retail radar screen, and not just in terms of its new low-end line. Last spring Hammacher Schlemmer, a retail catalog company, approached Stack with a request to carry the company's high-end Pro Fitter, a $500 machine that simulates skiing. Discovery Channel Store showed up on Fitter's doorstep last summer and expressed interest in carrying wobble boards in the coming months. Road Runner Sports, the largest running store in the world, doubled its order of Fitter products. In 2002 the company's projected revenue was $4 million.

Stack is already filling hundreds of orders from his existing retail customers and from those he's met at industry trade shows, such as the Outdoor Retailer Show in Salt Lake City. But he hasn't given up on Target. "Big stores take a long time to make decisions," he reasons. "But specialty retailers are much faster, and they create momentum for new products." So he'll go back to Target over the coming months with the hope that he will have already generated buzz in the marketplace. His long-term goal: to see Fitter's retail sales climb to 50% of its revenue and "to make our products a commodity and for Fitter to be the leader." Still, Stack is cautious. "I don't want to get too thinly spread and implode," he says.


The Experts Weigh In


Should Fitter Do the Deal?

Jim Spring, president, Leisure Trends Group, an outdoor-recreation-industry consulting firm in Boulder, Colo.

Rating: 6 (on a scale of 1 to 10, with 10 being "absolutely yes")

"Fitter is taking too big a risk chasing the Target offer. To do it, the company will need to raise money and create a new brand identity. Beyond that, it will need to know from Target when it will get paid, that it will not be required to take product back, that Target will not substitute its own brand for the Fitter brand, and that Target will share accurate sell-through information so that Fitter can forecast demand and not find itself with too much inventory. If Fitter doesn't work out an appropriate deal with Target, it should instead become more aggressive in channels where demand for fitness products is established, developing its brand for sporting-goods stores and broadening its catalog business."


Therese Iknoian, copublisher of Specialty News, an outdoor-and-fitness-industry newsletter based in Grass Valley, Calif.

Rating: 4

"By filling the Targets of the world with exercise balls and balance boards, Fitter may find a consumer that won't venture into specialty retail or pay high catalog prices. But I don't believe that Stack is one to abandon his values or to lower his quality. That would dilute the power he has in the market, which is solidly at the high end. Sure, the mass-market move would catapult him forward, but it would also take him 10 steps back financially. And even if he did decide to come up with another, lower-priced brand that he would market to big-box stores, Target might decide two years from now that it doesn't want his product. I believe that Stack should stick to his high-quality brand and product to keep him fiscally happy and emotionally satisfied. Target isn't the gig for him."


David S. Moross, chairman and CEO of Falconhead Capital, an investment company specializing in the sports and leisure industries, based in New York City

Rating: 5

"In spite of the company's $3 million in sales, Stack needs to look at the potential relationship with Target almost as a start-up. There is $315,000 of start-up expense, a completely redeveloped product, and a new distribution channel. In addition, Stack needs to seriously evaluate the risk of losing his existing client base since he may be diluting his 'expert niche' brand position by moving to mass-market and specialty-retailer distribution. If he alienates his high-end customers, he will ultimately exist only at the behest of Target. And moving from niche distribution to the mass market, where Fitter is suddenly competing with powerful brands like Nike and Reebok, is troubling and fraught with risk. Those brands have power not only with consumers, by virtue of their massive advertising spending, but also with retailers."


Please E-mail your comments to editors@inc.com.

Last updated: Jan 1, 2003

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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