Why was David Cook so glum? Investors had responded enthusiastically to the initial public offering for his company, and Cook had $8.4 million in the corporate treasury. There was just one small problem: a few months after the offering in 1983, Cook became convinced that he couldn't invest a single dollar of it profitably in his business.
There is such a thing as raising red flags in your prospectus, but this was ridiculous. Cook, whose company wrote software for oil companies, had planned his future around a healthy petroleum industry. But six months after the IPO, oil prices started to slide.
So what were his alternatives? He could dig in his heels like thousands of Texas oil executives and wait for better times. Or he could go into another business altogether.
What Cook had built since 1978, and what investors had bought, was a company that had more than doubled its sales in each of its first five years, peaking at $6.1 million in 1982 with $901,000 in earnings. Oil and gas companies paid as much as $120,000 for Cook Data's economic-analysis software.
But the oil companies were cutting back their expenses, and sales of Cook Data Services Inc. plummeted 41% in the quarter following the IPO and kept right on fading -- as did the stock, which dropped from its offering price of $16 in February to a low bid of $10 by the end of the second quarter. Even as sales evaporated, operating costs were up 26% for the year 1983, as a result of rapid staff and office expansion in anticipation of growth. And things only got worse: in September, stockholders filed a class-action suit charging that the company had made misleading statements about its earnings prospects.
As far as Cook was concerned, earnings prospects were now clear -- there were no prospects. The company was left in the "very delicate position of having been given all this money and then finding the industry we were going to invest in had gone away," Cook recalls. All over the oil-producing region, companies connected to the oil and gas industry were laying off thousands of workers. Office buildings were coming to completion without tenants. The average selling price for a single-family house in Texas dropped 3% between September 1983 and March 1984. Determined not to invest in an industry that "a child of seven could see was going to hell," Cook didn't dare commit the IPO cash to the oil business.
So what was Cook to do? He figured it was too late to rescind the IPO and give the money back to investors, and besides, "when you buy any small company you're buying management," says Cook, not just the line of business. While he tried to figure out what to do next, Cook devised an operating plan that called for centralization of certain operations and staff reductions pegged to a series of revenue benchmarks. During the balance of 1983, he closed one branch office and slashed staffing to 41 -- a 37% drop. "Emotionally, I was destroyed," he says. "These were people who had come from other jobs for a future at our company, and we were laying them off. Many of them had been friends, and none of them had done anything wrong."
By early 1984, Cook knew he had to exit the oil business. But giving up on his founder's dream was a tough thing to do voluntarily. "One day you feel like you're the king of the industry, and the next day you feel like you've failed miserably," says Cook. "It reflects on your self-image, self-respect, and confidence, and you begin to have doubts as to whether you're as good a manager as you thought you were."
First he considered investing in computer-related start-ups, which at least seemed a compatible field, and went as far as investing $500,000 in a small company developing an electronic-identification system. But Cook wanted to run a new business, not a venture capital fund. So in the spring of 1984, he hired strategic planner Chet Mills to design a "strategic sieve" through which Cook could sift every conceivable enterprise. "We had three pages of criteria. We were looking for a fragmented market without dominant players, a business that could be set up on a local basis and easily replicated in other markets, and a business where we could throw up some competitive barriers," he says.
Cook finally settled the stockholder suit in April 1985 by issuing 230,000 shares of company stock to the plaintiffs, worth $862,000. The settlement precluded the stockholders from again suing in connection with the offering.
The settlement was Cook's green light, and he moved quickly. He sold the company's energy-software operation in July for about $2.5 million. Now, with only four employees, the company had roughly $9.2 million in cash and no debt -- a rather rarefied position in the Texas of 1985, where 10-gallon hats were selling for a song. "Overall, it was like somebody handing me $10 million and saying, 'Here, develop a new business," Cook says.
The one idea for a new business that complied with his list of criteria was video rentals. In five years, videocassette-recorder penetration of U.S. households had jumped from 2% to 21%, and the videorental business had zoomed from less than $1 billion in 1983 to $3.7 billion by 1985. With VCR prices falling and home movie viewing becoming an ingrained national habit, the industry's future looked brilliant.
The rental industry, though, was comprised of a growing army of thinly capitalized mom-and-pop proprietors scratching out neighborhood claims. The small videorental operator, faced with scraping up $30,000 to $50,000 in start-up capital to open a store with several hundred tapes, was hedging on inventory selection and management, areas Cook Data could attack aggressively with its cash and its computer expertise. The company had plenty of models for conquering fragmented markets: Toys "R" Us Inc. had done it in toy retailing and The Southland Corp. in convenience stores, to name just two.
Cook's concept: pour up to $700,000 into superstores that offer long hours, quick service, and a selection of 7,000 to 12,000 tapes. He figured a typical store, located in a densely populated metropolitan area, should generate about $60,000 a month at a profit margin that would make payback of the initial investment achievable in two years. And a half-million-dollar tape inventory would be a formidable barrier for small operators to overcome. "We're applying technology and large-scale distribution concepts to an emerging market that's in its infancy," he says. "There's nothing magic about it. We're just the first to do it in this industry."
But before Cook could build a prototype to prove the soundness of his concept, he was faced with a few barriers himself. Since he had no experience in a retail business, he had to recruit a management team of executives seasoned in retailing and distribution. His company, now named Blockbuster Entertainment Corp., had been accustomed in its earlier incarnation to preferred treatment from vendors. Now it groveled along with small-time video-store operators at the feet of major tape distributors. "They didn't let us have more than $1,000 credit," Cook says. "We'd send them a balance sheet and they'd say, 'Fine. Where's your personal guarantee?"
Once the prototype store was running, with customer response and sales surpassing projections, Cook shaped a plan he hoped would lead to national dominance. Blockbuster would concentrate on finding licensees who would agree to open multiple stores in major markets. Utilizing huge economies of scale, it would sell its licensees the entire contents of a store, including computer bar-coded tapes, special shelving, and computerized sales and inventory systems, earning a 20% markup on the complete package as well as a fee of 5% of store sales. In addition, the company planned to own and operate about 20 stores in Dallas.
By this May, Blockbuster had opened 15 of its own stores. Its licensees had opened another 20 stores in eight cities. And the company reported a first-quarterly profit of $397,000 on sales of $6 million. It was a fast start for the company, and a tangible indicator that Cook's concept for attacking the fragmented video market would work. Even if it did, Cook himself worried about the possibility of a large retailer competing against Blockbuster -- if K mart Corp., for instance, were to devote more of its space to video sales and rentals, its 2,200 stores might dominate the market overnight.
In the spring Cook relinquished control of Blockbuster to H. Wayne Huizenga, a cofounder and former president of Waste Management Inc., the $2-billion waste-collection and disposal company. Cook, who calls it a "very friendly transition," is planning the start-up of a high-technology company.
As he looks back on Blockbuster, Cook thinks he has learned a very important lesson. Had he persevered in energy software, he thinks his company might now be among the 10,304 bankruptcy cases pending in Dallas. He survived that fate by that rarest of feats -- by backing off from the company and eyeing it in a kind of cold light that entrepreneurs are rarely able to cast on their companies.