It was one phone call that John Malec didn't want to make.
From mid-1977 to the end of 1978, Malec had unsuccessfully tried to assemble $3 million to start his company. His search took him to conventional sources of capital -- mostly banks -- and to unconventional ones. He met with a man who claimed to be a millionaire prince from Bangladesh. He talked to a loan shark masquerading as a New York investment counselor. He even contacted a small business investment company affiliated with the Arapaho Indians. None of these excursions had panned out, and in late 1978, the last big Chicago bank he tried had said no. The most Malec had been able to come up with was a $250,000 Small Business Administration guaranteed loan from his neighborhood bank in Barrington, Ill.
Malec had long resisted calling the people who he thought would be most likely to back him -- venture capitalists, on the one hand, and his erstwhile colleagues at a couple of big marketing-research companies on the other. Surely, he thought, these sophisticated players would understand his business proposal, and certainly most of them knew his reputation as a very brash, very smart marketing-research executive. Just as certainly, they would demand a big piece of the pie and a major say in how the plan was carried out. "It was too big a risk," Malec explains. "The reason I wanted to start my own company was to have the control."
By January 1979, though, Malec felt he had no choice. If the company was ever to get off the ground, he and partner Gerry Eskin, a consultant and University of Iowa marketing professor, needed a lot of money. So Malec telephoned A.C. Nielsen Co.'s suburban Chicago headquarters and made a luncheon appointment with the senior vice-president of the company. Nielsen, the nation's largest marketing-research firm, was big and bureaucratic, Malec figured, but at least it had plenty of cash to seed new ventures.
"Gerry and I had lunch with this guy," Malec recalls, "and I laid out the entire plan, described it in detail. At the end of the lunch, the man paused and shook our hands. Then he looked at us and said, 'This is the dumbest idea I've ever heard."
A Nielsen spokesman confirms Malec's story, adding meekly, "Yep, that's what happened." Remembering the incident, Malec grins. "I realized at that point," he says, "that Nielsen would never be a serious competitor."
What Malec explained over lunch was his personal vision of the marketing-research business, a vision that is now waking the $1.5-billion industry up from a long, lazy nap. His ambitious plan called for a computerized marketing-research system that would track consumer behavior with unheard-of accuracy, recording exactly what television shows and commercials consumers watched, then tracking what products the same consumers were buying at the supermarket.
Today Malec is chairman and chief executive officer of Chicago-based Information Resources Inc. IRI -- which ranked # 15 on the 1984 INC. 100 list of the fastest-growing public companies in the country -- registered estimated sales of $35 million in 1984, its sixth year in business. Eskin is vice-chairman, and the pair's aims are clear. "Our goal," Malec says flatly, "is to beat Nielsen, to be number one." Already IRI has fundamentally changed both the nature of marketing research and the way consumer-products marketers view the process.Its success, moreover, has forced competitors -- including Nielsen -- to scramble for a more sophisticated technological approach to the business of finding out what makes people buy what they buy.
"Perhaps we were being idealistic at the time," says Eskin, recalling the partners' early conversations over his kitchen table in Iowa City, Iowa. "We simply posed the question: 'What would make a perfect marketing-research instrument?' We set out to create the best of all possible worlds."
The instrument they created -- IRI's primary product -- is a revolutionary marketing-research service with the Orwellian name BehaviorScan. It works like this:
First IRI selects a representative sample of 2,500 or so households equipped with cable television in a market in which big packaged-goods companies like to test their new products. For the most part, these are medium-size cities, such as Pittsfield, Mass.
The company then installs an electronic device on each television in every selected household. The device monitors when the set is on and what station it is tuned to. Every night, this minute-by-minute record is transmitted to Chicago, where it is logged in by a computer in the basement data center at IRI's headquarters.
That same computer is hooked into the electronic scanners -- cash registers that read the Universal Product Code -- in every large grocery store in the test cities. When a member of the BehaviorScan sample group goes shopping, he or she shows the cashier a coded plastic ID card that looks like a credit card, and the cashier keys in the number. The number, in turn, forms the link between the consumer's item-by-item purchase record, which the store transmits, and the television viewing data, which comes from the device on the home TV. The computer puts the two together, adding in the extensive demographic information on file for each household in the sample.
As a final, Big Brotherly refinement of the system, IRI is able actually to decide what advertising the family sees. The electronic device on the television sets allows the company to cut into the regularly scheduled broadcast, substituting a test commercial -- one introducing a new product, for example -- for a commercial that is transmitted nationally over the TV network. In addition, IRI arranges with local newspapers and national magazines to print special editions for the test households. Thus, one household may get its morning paper with a cents-off coupon for a test product, while the house net door receives a regular newspaper with no mention of the product at all.
The net result of this electronic embrace is that IRI can answer, with unprecedented speed and accuracy, such critical marketing questions as what sort of advertising works best, how much advertising is cost-effective, and how successful a new product is likely to be. It is hard to exaggerate how dramatic a change this is from the old methods of marketing research. Despite the high stakes involved -- launching a new brand in a hotly competitive consumer-products business like snack foods or shampoo often costs more than $50 million -- traditional marketing research was cumbersome and often unreliable. More importantly, perhaps, the research data came from several different, unrelated sources.
Until 10 years ago, for example, companies wanting to gauge consumer acceptance of a new product generally had to rely on a limited number of competing systems (one of them Nielsen's) that provided monthly reports on supermarket inventories. Point-of-sale scanners, introduced in 1974, promised vastly greater speed and accuracy for determining what was selling in supermarkets. But scanners were expensive and slow to catch on. To find out which consumers were buying which products, manufacturers usually hired research firms that, in turn, signed up a cross-section panel of households to keep diaries of their everyday purchases, a system that was vulnerable to carelessness or forgetfulness on the part of the consumers. Meanwhile, to determine what people were watching on television, marketers relied on the Nielsen or Arbitron ratings.
One research service that did forge a link between the two types of data -- and that served as a model for IRI -- was AdTel Inc., founded in 1968. In cities with two cable systems, AdTel arranged to run different ads on the two systems, then used diary panels to test the impact of the ads on sales. Although the concept was a financial success, the company took several months to sort out the data and report to clients. And AdTel didn't substantially refine its methods.
So the BehaviorScan concept marked a significant breakthrough -- and indeed, IRI had relatively little trouble selling its new service to the big package-goods companies. Setting up the business, though, was another matter altogether. In effect, Malec and Eskin and their partners had to reinvent the marketing-research firm. They had to create a high-technology company in an industry that was notoriously low-tech. They had to develop substantial capital resources in an industry that traditionally operated with high labor costs and very little capital. And then they had to go out and sell this strange new company not simply to the buyers but to wary suppliers and consumer participants as well.
The challenge, in short, was to transform a good idea into a company that would revolutionize an industry.
These tasks fell to a rather unlikely pair. Malec, 40, grew up in Pewaukee, Wis., six miles west of Milwaukee. He studied marketing in college and spent three years in the Navy, including a tour of duty in Vietnam. Then, he got into the marketing-research business when he joined a consulting firm that used the diary panels, later becoming owner in charge of the Chicago office of NPD Research Corp. (now NPD Group Inc.), one of the nation's leading diary panel suppliers. An aggressive competitor with a personality some have termed abrasive, Malec participated in the Olympic sailing trials in 1972 and today races his 45-foot sloop in major events across the country.
Eskin, a donnish 50-year-old, trots around IRI's Chicago offices in tweed jackets. After graduate work in economics at the University of Minnesota, he taught marketing at Stanford University and the University of Iowa, and began a consulting practice, serving such clients as Pillsbury Co. and Quaker Oats Co.
The two men got to know each other in 1974, a time when Malec was growing disenchanted with his partners at NPD. By his own account, Malec helped the firm grow from $400,000 to $7 million in seven years. But he had lobbied hard and unsuccessfully for the company to invest in electronic devices to capture panel data, replacing the manual coding system that NPD had used for years. "There was a basic reluctance on the part of my two partners to view the research business as something that you could get a return on invested capital in," Malec says. "In the finest research company tradition, they believed that you only spent the money you got from a job, not your own money in hopes of getting a job."
Frustrated by the situation, Malec decided to leave. The parting was reportedly messy: Tales of locked files and sealed offices surround the incident. Neither Malec nor NPD president Tod Johnson will discuss it.
Malec, Eskin, and Penny Baron, another Iowa marketing professor, began to talk about a business that would use scanners to gether purchase data and somehow connect that information to other market research. "It became clear we would have to substantially structure the environment," recalls Baron, who joined IRI but left in 1981 to return to teaching and consulting. "We had to make the environment the way we wanted: Find a market, give the stores scanners, deliver the ads to households -- and get people to cooperate with us each step of the way."
The first challenge was technological. The sine qua non of the partners' plan was the cable converter that would allow them to run test commercials on television sets in their test market. Scraping together $250,000 of their own money -- which Malec says is all the equity they ever put into IRI -- they hired an electrical engineer to develop a prototype.
"We knew it was possible," says Malec, "because porn movies were delivered in hotels in much the same way that we wanted to show the commercials, over unused cable frequencies." This insight led them to Bark Lee Yee.
Yee has owned a cable television system in Allentown, Pa., for more than 20 years. It was one of the first in the country to transmit blue movies over cable. Yee is also president of RK Electronics Ltd., which sells converters for pay-per-view programming -- usually pornography -- such as those found in some hotel rooms.
"One day I got this call from Gerry Eskin," recalls Yee. "He said he had heard about me and my company and wanted to talk to me. I said sure, fine. Five minutes later he walked into the office."
Yee, himself an entrepreneur, was enthusiastic about the project. If it worked, Eskin promised to buy around 5,000 converters from RK Electronics. So Yee turned over his cable studios to Malec, Eskin, and their engineer to perfect the device to cut in commercials. Malec and the others patented the new technology, a move that has proved important: The patent has provided the first line of defense for IRI against the larger competitors that are now trying to muscle in on its turf.
The three partners were designing the elaborate research methodologies for the project. Because none had the computer-systems design background necessary to create such a complex program, they recruited a new partner, Bill Walter, then a systems designer for a marketing-consulting firm.
"Bill Walter had an almost impossible task," says Baron: "To figure out a way to catalog almost 11,000 items in a grocery store. And he knew he wasn't going to get 18 systems programmers and the latest computers to do it. He was going to have an old, rickety IBM computer and he was going to have himself. That was it."
Walter wasn't the only one facing an almost impossible task. Traditionally, marketing research is a labor-intensive proposition, and launching a company requires only enough money to open an office and hire some help. IRI's system of converters, scanners, and computers, by contrast, would require large infusions of capital to design and assemble. For Malec's team, this was strange territory. "None of us had done anything financial," he says. "It was our fatal flaw in the early stages. We had to double our figures."
Nor was finding the money going to be easy. To install scanners in supermarkets in Marion, Ind., and Pittsfield, the two markets they had selected for BehaviorScan, would cost at least $1.5 million. But "none of the big banks would talk to us," Malec recalls, and the SBA loan that did come through wasn't nearly enough to launch the company. Nielsen, of course, turned them down.
In early 1979, Malec and Eskin came up with an imaginative first step. They approached potential clients with their idea and convinced several to sign conditional contracts calling for an immediate 50% payment on the first day of business. "That money ensured an immediate cash flow," Malec says. Then, with contracts in hand from well-known companies, Malec thought IRI would be able to get conventional financing. But he was wrong. And until the group could get the money for the scanners, there could be no company.
They tried every way they could to conserve their cash. The television studio equipment and converters were "supplier-financed, although [the suppliers] didn't necessarily know they were doing that when we placed the order," explains Malec with a wry smile. They arranged to lease rather than purchase the scanners from National Semiconductor Corp.
With the technology still under development and the capital problem still unsolved, IRI had to go about selling itself to the array of constituencies whose cooperation it needed: clients for the BehaviorScan service, the retailers that would provide scanner information, the cable-television companies that could offer access to TV systems, and most importantly, shoppers in Marion and Pittsfield who would participate in the test.
Clients, Malec and Eskin had begun to discover, were the easiest sell. "There really was no risk, no up-front money required," recalls Joel Dubow, manager or communications research for Coca-Cola USA. "We knew John and Gerry as reliable people with good reputations. And while we couldn't be sure all the kinks were out of system when their doors opened, we felt pretty confident it wouldn't flop." Cost considerations alone provided a compelling marketing advantage for IRI. While the total cost of a conventional market test typically runs upwards of $3 million, a BehaviorScan test is in the $2-million range -- and with recession looming on the horizon in the late 1970s, companies were looking for ways to trim their expenses. As one sale led to another, word of mouth quickened the project's pace; Malec told clients he would open for business in September 1979. His first 11 clients were a blue-chip group that, in addition to Coke, included Procter & Gamble, Kraft, Clorox, and Scott Paper.
The shoppers themselves were not hard to win over, either, although IRI approached them with some trepidation. "Remember, we were going into people's homes with this box," says Eskin. "We were worried that there would be some sort of backlash over invasion of privacy." To sign up local residents for "Shoppers Hotline" -- the name used by IRI in the markets for BehaviorScan -- they used a standard research company tactic: annual gifts and monthly prize giveaways. In exchange for their help, the sample households could win blenders and gift certificates. "It actually turned out to be pretty easy," says Baron. "Most people view market research as both fun and useful. They like being a part of the process."
Convincing retailers and cable companies, however, proved to be a different story. In Morion and Pittsfield, retailers were wary of divulging any information about their operations.Cable companies were suspicious of outsiders interfering with their business.
To gain access to the cable systems, IRI offered operators a flat fee or a percentage of the gross receipts from the commercial substitutions. To get the supermarkets' cooperation, IRI promised to buy and install scanners for them, free of charge. At first, the tactic didn't work. "We sent them letters explaining that we wanted to give them free scanners," says Lin Stanley, one of IRI's first employees, who is now senior vice-president for scanner operations. "When I called to follow up, most of the people had to search their garbage cans for the letter. They thought it was a come-on, a fake. Why would anyone want to give away scanners?" Eventually, through patient explanation of the company and its system, plus the endorsement of its service implied by the big marketers' contracts, IRI was able to convince the retailers.
As the launch date neared, all IRI needed was money. But it needed it badly; in fact, the cash crunch threatened to choke the company. "We were paying the few employees we had out of our own checkbooks," says Malec. Worried about losing it all, Malec had asked his attorney to search for an investor.
Finally in August, IRI found its financial angel and a short-term solution to its capital needs. Malec's attorney had a rich client, Lowell Fixler, who met with Malec and Eskin, heard their plan, and agreed to buy 18% of the stock for $250,000.
On September 3, 1979, Information Resources Inc. opened for business. There were a few unexpected problems. In Marion, located in the heart of central Indiana's Bible Belt, religious groups started distributing literature at supermarkets that claimed the scanners and the UPC code were somehow linked to the Devil. "There wasn't much we could do about that," says Baron. "If you're convinced that evil lurks under the grocery store checkout counter, well, that's a pretty serious level of concern. Those people didn't sign up."
For the most part, though, the impact was swift. Probably no more than 150 companies have both the research demands and the financial resources for BehaviorScan, and word soon spread among them that Malec and Eskin had gotten IRI off the ground. "They were written up all over the place," says Jack Honomichl, Advertising Age's research columnist. "John and Gerry were invited to speak at industry meetings. By the standards of the research industry, it was all extremely flattering."
"IRI has changed the game as we all knew it," says Reg Rhodes, president of Burke Marketing Services' Test Marketing Group. "Technology is now driving the category."
Only the money problem -- finding capital for long-term growth -- remained. Now that the concept had been proved, IRI could leverage its research by adding new products, such as a series of Marketing Fact Books, reference works containing nonproprietary information the company had turned up. But IRI also needed to add more BehaviorScan markets. Because confidentiality is so important in marketing research, IRI's contract offers clients exclusive rights to a category. If Nabisco Brands Inc., for example, is testing a new cookie in Pittsfield, IRI won't put Keebler Co.'s products there. By the summer of 1981, IRI had found its next two markets.
This time, finding capital was a little bit easier. "I got a phone call out of the blue from William Blair & Co. [a Chicago investment firm]. They said, 'We have a company interested in taking a minority position in IRI. Do you need any money?" Malec snapped it up. The company, Automated Marketing Systems (AMS), bought 20% of IRI's stock and an option to acquire the rest of the company.
Why, after avoiding venture capital and larger-company partnerships in the beginning, did Malec change his mind? "It was a relationship we always thought we could control," he explains. "AMS was in a business that didn't have a large intellectual component. They could not, in our opinion, come even close to running our business without us, so we felt we were always in the driver's seat." One year later, Malec and his partners bought the stock back from AMS for "slightly" more than they had sold it for.
Ever since IRI opened for business, Malec and Eskin had shrewdly moved to capitalize on the company's image as an innovative upstart. In speeches, Malec played up IRI's technological foundations, hailing it as the "high-tech" alternative to existing research services. Now this image-building was beginning to pay off. "IRI rode the wave of the interest in technology," says Tony Adams, Campbell Soup Co.'s marketing-research director. Says one IRI competitor: "Companies were salivating to find out more about them."
In mid-1982, Malec dipped into the venture capital market, with the idea of setting the stage for a public offering. He signed on with Hambrecht & Quist Inc., a leading underwriter of high-tech companies during the blazing market for initial public offerings in 1982 and '83. "The very fact that Malec went with H&Q was all part of the gestalt of the company," says Honomichl. "It implied that the company was on the cutting edge."
IRI sold around 3% of the company's stock to H&Q, which later invited Greylock Investors & Co. into the deal. H&Q senior vice-president George G. Montgomery Jr. and Greylock president Henry F. McCance were named to the board, which began mapping out a strategy to take the compay public in the spring of 1983. Their timing could not have been better: The market was red-hot for technology-based initial public offerings. Malec and Gian Fulgoni, the chief operating officer hired in 1981 to manage the business, set off on a grinding eight-day, 10-city road show to explain their company to investors. "The financial community was numb from the endless presentations on hardware, software, disk drives," says Fulgoni. "And suddenly, in we walked, talking about Cheerios and Corn Flakes. It caught people's attention."
It did indeed. The stock, price at $23 a share, skyrocketed to $43 on the first day of the offering, and in August 1983 split 2 for 1. The offering generated $18 million to pay off IRI's long-term debt and finance its expansion. It also made the four partners overnight millionaires: Malec, for example, controlled 21% of the stock at last report -- holdings that by year-end 1984 would have totaled some $45.5 million. And IRI's employees share in the company's good fortunes: 40% of IRI's full-time personnel hold stock options.
In keeping with Malec's philosophy, investment spending remains high for a company of IRI's size. In 1983, net earnings were $3.7 million, yet the company spent around $8 million for four new BehaviorScan markets, and it has had a five-fold increase in its computer capabilities. It has also added drugstores to the BehaviorScan testing in six of the eight markets, a key step in a growth plan that Malec says will take it to the top of the industry. By the end of 1985, IRI plans to have 35,000 panelists, one of the largest samples in the marketing-research business.
For their part, IRI's rivals say they have finished licking their wounds and are ready to respond. This month, Nielsen, now a unit of Dun & Bradstreet Corp., will launch its own electronic test marketing system, ERIM Information Services, in Springfield, Mo., and Sioux Falls, S. Dak. Patterned after BehaviorScan, Nielsen's technology sidesteps the cable systems by installing antennae on test households that allow over-the-air transmission of the commercial cut-ins. That gives Nielsen greater freedom in choosing a sample. The company says it will spend more than $10 million -- the biggest new product investment in its history -- on the research, development, and start-up of ERIM.
Burke Marketing Services, meanwhile, bought AdTel in September 1979, and, since 1980, has begun to substitute scanner data for diary panel information. It is developing its own targetable television device for commercial substitutions. Burke is reported to be experimenting with an in-home scanner that will measure all UPC-coded products, not just those purchased in a supermarket or drugstore. And AGB Research Ltd., a giant British firm, has announced an ambitious plan to use a new type of metering technology in the United States.
Malec is unruffled. IRI has sought to protect its competitive position through the courts -- the company has a patent infringement suit pending against Burke, among other lawsuits -- as well as through continued technological improvement. "It would be naive of anybody to think that we're standing still while they're catching up to where we used to be," he says. "I don't see anybody having a competitive advantage over IRI in these new technologies."
And for all their interest in technology, Malec and Eskin have always believed that ultimately IRI is a service business -- and in a service business, people are more important than machines. The two are thus decentralizing the company as it grows, in an attempt to provide opportunities for employees. Each new division is treated as a profit center. "John has made a conscious effort in the past year to create an entrepreneurial feeling in the different divisions, much in the same way he and his partners had for the company when it was much smaller," says Greylock's McCance.
Sitting in his office, Malec reflects on where the company was and where it is headed. Ultimately, he acknowledges, his rivals may catch up, invent a better black box. "But the competition will shift from a technological advantage to a people advantage. It's there where the game is going to be won or lost."
Losing is not Malec's idea of a good time. Last summer, he skippered his sailboat to a second-place finish in the 333-mile Chicago-to-Mackinac race. "It was one of the closest finishes in history -- 12 seconds," he says, "and we were on the wrong end of it." Telling that tale exasperates him. But he'll be back in the race next year. Malec doesn't like to finish second.