The $29 million lesson

COMPANIES

by Alyssa A. Lappen
Forbes | Feb. 24, 1986

Vol. 137., No. 4, pp. 64-65
919 words

If the best lessons are the most expensive ones, Donald Gustafson has bought himself a fine education. Six years ago Gustafson’s stake in the little office equipment company he started, Kroy Inc., was worth $40 million. Today it is worth $11 million.

“I have learned a marketing lesson, and I hope it’s one of the last we ever learn,” Gustafson, 67, grimaces. Asked to articulate the $29 million lesson, he replies: “That [by pushing] sales growth at the expense of profits, you’ll self-destruct.”

Let’s back up. Gustafson, formerly a vice president at a Minneapolis bank, bought control of Kroy, then a thermoplastics company, in the 1960s. Kroy developed a nifty lettering machine, which resembles the Dymo labeling gun, except that Kroy’s rotating-disk fonts type black letters onto clear tape. Press the tape onto a paper master, make a copy and presto! all you see is a typeset headline. The machines became a success with engineers and architects, but now anyone with reports and memos to jazz up can use them. The cheapest ones sell for $295; for $2,495 you can get a fancy electronic keyboard that lets you type over errors.

Gustafson sold the machines through a network of 1,000 independent office supply dealers around the country–“peddlers,” Gustafson condescendingly called his dealers. But the peddlers knew their territories and helped keep Kroy’s overhead down. By 1982, when FORBES wrote glowingly of the company, Kroy’s sales had reached $44 million, profits $6.1 million (FORBES, Dec. 20, 1982).

Now comes Gustafson’s expensive education. Kroy’s 36% return on equity, Gustafson reasonably figured, was bound to attract competition, maybe from such office products giants as IBM, Wang, Sperry or Exxon. To get the jump on the giants, Gustafson decided to expand his product line to include high-priced computerized headline writers with electronic keyboards and cassette memory banks. Price, when the product finally arrived: $4,995. To move these upmarket machines, Gustafson decided to dump his 1,000 “peddlers,” on the grounds that independents would not be up to the task of selling against the button-down boys from IBM.

No matter that the idependents knew their markets and their accounts, many of them small local businesses. No matter that Gustafson had to start his new marketing force from scratch. In place of the independents, Gustafson hired a direct sales staff of 140 to workout of 23 branch sales offices and put them in competition against Kroy’s old “peddlers.” The predictable results were (1) some very hard feelings and (2) internal chaos. In the midst of all this, Gustafson moved Kroy’s headquarters to Scottsdale, Ariz., where he planned soon to retire.

By fiscal 1983 (ended March 1983) Kroy’s sales had climed to $47 million. Profits, however, fell nearly a third, to $4.5 million. The new generation of letterers was delayed, forcing Gustafson’s expensive new salesmen to move the older, cheaper models. Rather than throttle back on his new marketing strategy, Gustafson hired 110 more salesmen. By fiscal 1985 sales had reached $66 million. But operating earnings had all but evaporated.

Gustafson had also erred in 1981, when he asked Scott drill to take over Kroy’s Far East sales. Drill, who had been Kroy’s international sals manager, took the offer as an insult. In February 1983, as Gustafson fretfully scanned the horizon for competition that failed to appear, Drill started Varitronic Systems and eventually took 14 other frustrated Kroy managers out the back door. Varitronic quickly came out with a couple of Japanese-made lettering machines. Dubbed “Merlin,” Varitronic’s machines are similar in principle to Kroy’s but are smaller, twice as fast and cheaper.
Drill already had a willing sales force: the independents over whom Gustafson had run roughshod. Just 14 months in business, Varitronic has already sold $20 million worth of Merlins and now wants a piece of Kroy’s tape and carbon supply business as well. “If you are writing about Kroy,” a jubilant Drill tells FORBES, “you are writing about the wrong company.”

Couldn’t Gustafson have soothed Drill and the other defectors? Possibly. But he had already repaired to Scottsdale to play golf and oversee the corporate move.

Sublesson here: If you push people around, don’t be surprised when they shove back.

Finally, in February of last year, Gustafson brought in Errol Bartine to clean up the mess. Bartine, 54, a former planning director and corporate vice president at Sperry and AM International, immediately began closing Kroy’s new sales offices. On average, each of Kroy’s salesmen was producing less than $200,000 annually in sales. “If you can’t get $400,000 to $500,000 [in sales] per salesperson per year, you have no business trying to maintain a direct operation,” says Bartine, who has already shuttered 11 branches and laid off a third of the company’s work force, which now numbers about 700.

Now Bartine is sorting through the ranks of his remaining 400 “peddlers,” begging the good ones to forgive and forget. He now has 80 high-volume dealers and hopes to build that to at least 225. On a less positive note, Bartine is suing Varitronic for patent infringement.

Bartine’s most recent report card is impressive. Kroy’s operating expenses were down 25% in the first nine months of fiscal 1986 (ending Mar. 31). Earnings were back up to $4.8 million on sales of $45 million, compared with less than $1 million on sales of $49 million in the same period last year. If bartime can maintain this pace, the $29 million hit to Gustafson’s net worth will have been tuition well spent.

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Alyssa A. Lappen

Alyssa A. Lappen is a U.S.-based investigative journalist. She is the former Managing Editor at the Leeb Group (2012-2017); a former Senior Fellow of the American Center for Democracy (2005-2008); and a former Senior Editor of Institutional Investor (1993-1999), Working Woman (1991-1993) and Corporate Finance (1991). She served six of her 12 years at Forbes (1978-1990) as an Associate Editor. Ms. Lappen was also a staff reporter at The New Haven Register (1975-1977). During a decade as a freelance, her work appeared in Big Peace, Pajamas Media, Front Page Magazine, American Thinker, Right Side News, Family Security Matters, the Washington Times and many other Internet and print journals. Ms. Lappen also contributed to the Terror Finance Blog, among others. She supports the right of journalists worldwide to write without fear or restriction on politics, governments, international affairs, terrorism, terror financing and religious support for terrorism, among other subjects. Ms. Lappen is also an accomplished poet. Her first full-length collection, The Minstrel's Song, was published by Cross-Cultural Communications in April 2015. Her poems have been published in the 2nd 2007 edition of Blood to Remember: American Poets on the Holocaust and both 2007 issues of Wales' award-winning Seventh Quarry: Swansea Poetry Magazine. Dozens of her poems have appeared in print and online literary journals and books. She won the 2000 annual Ruah: A Journal of Spiritual Poetry chapbook award and has received a Harvard Summer Poetry Prize and several honorable mentions.