It was a dark February night in 1994 when I boarded a late plane from New Orleans headed home, dealing with impending doom. It’s the only time I ever asked for a changed seat for health reasons. Claiming severe claustrophobia (an exaggeration), I got my seat switched from a window in the middle of the plane to an aisle in the extreme rear. Everything about that flight remains engraved in memory wrapped in darkness and doom.
I felt lost and alone a few times during my career, usually in the deep on night in lonely hotels halfway around the world from home, the depths of business travel, my consulting years. A few times in airports, in Asia and South America. But never as alone as I felt that night, traveling with Paul B., my supposed partner since 1993, “my sales guy.”
The Huge Problem
“Tim, your boxes suck.” The words of Kathy Colder, a VP for the Fry’s retail chain of computer stores, rang in my ears. Fry’s was a big deal back then, a major retail channel, a market leader in the Bay Area, California, and the West Coast. And Kathy owed me nothing, had no reason to share the real truth, but did it out of generosity. She could have said nothing. She meant it as useful advice. It was her response to my expression of horror as I discovered, in her presence, the concept of “sell-through.”
Sell-through was the immediate problem. I discovered, to my horror, that sales recorded as sales when they went into the channels weren’t really sales until the end user bought the product off of the retail shelves. I didn’t know that. Way worse, Paul B., my would-have-been partner, the one with the retail knowledge and experience, didn’t know it either. We were operating blind. Everybody else in the business tracked their sell through numbers carefully, but we didn’t even know they were available to us. We thought we’d sold a million dollars in 1993, but we actually owed $250,000 of that back to them. we’d sold them to distributors, who’d sold them to retail stores, who put them on shelves; but they didn’t sell through from the shelves. They sat on shelves unsold. And we had to take them back and return the money. And that included the boxes Paul Berger had given them for free, as promotional.
“Your boxes suck,” Kathy Colder said. “You designed them for yourselves but they are too drab. Go look at packages in a supermarket. Packages are supposed to sell, not to sit on a coffee table somewhere.”
Meanwhile, we had three kids in Notre Dame, Princeton, and NYU. The tuition expenses, after loans and scholarships, were about $75,000 per year. Palo Alto Software was our only income. We had next to nothing in savings. We’d left Palo Alto for Eugene in part to clear up our entrepreneurial finances, meaning we’d had three mortgages and $65,000 credit card debt at the worst point. We sold a nice home in Palo Alto and bought our longtime home in Eugene for half the proceeds.
The Bad Deal
Paul B. contacted me in 1992 shortly after we moved to Eugene. He’d been marketing packaging software for a Eugene entrepreneur whose sales had grown past three million dollars per year. He wanted to do it for and with somebody else; and as a partner, an owner, not as an employee. He offered to work for $1,000 per month (very little) if I gave him a shot at being half owner. My sales of template products ran about two hundred to four hundred thousand dollars a year, but that was less than my marketing expenses.
I made the deal with Paul B. I figured I had nothing to lose. Paul seemed to know how to build a software business with retail channels. We agreed that if he could get sales to $1 million in 1993, $2 million in 1994, and $3 million in 1995, then he’d acquire half ownership in Palo Alto Software. Of course I talked this over with Vange, and we both agreed that it was a reasonable risk. We were betting half of a losing and essentially failing business on making that a successful business. Furthermore, we didn’t have a lot of options. We had moved to Eugene. We lived off my consulting with Apple, which was mostly Apple Japan.
It turned out that there were two huge flaws in that deal. Both of which I had discovered in the two days prior to that long dark flight home.
First, Paul didn’t know the business nearly as well as he’d claimed. He didn’t know that sell-through numbers were available to us. He didn’t understand the importance of consumer goods packaging. He didn’t understand how sales into channels weren’t really sales; they could all come back.
Second, much more important, Paul B.’s targets were all about sales, and only sales, with no concern whatsoever for costs, margins, or returns. That was a big mistake. Paul B.’s incentives encouraged him to push up sales by pushing down prices. So Paul pushed the sales over the $1 million in 1993 by offering huge discounts to distributors just for putting our boxes on shelves. Buy two, get five was fine for him, because he thought that was a sale. In the last three months of 1993 he was giving so much away to channels that we were losing money on every unit. Margins in packaged software were running 85% to 95% (price less costs), but Paul had us running at about 10%, meaning that for every $60 unit we sold, we had about $54 in costs (mostly building other products that we were giving away for free). We weren’t covering fixed costs and expenses. Paul was destroying the business while increasing the sales.
Perhaps even more important, Paul didn’t understand retail software sales and the importance of the damned box. The box, the package, was 90% of the product’s sales pitch in one cardboard place. If the box didn’t sell it off the shelves, it wasn’t going to sell. Everybody in retail software — except me and Paul B. — knew that.
Of course it was all ultimately my fault. It was my business. But regarding sell through, returns, and packaging, I knew I didn’t know and I had reason to believe Paul did. He came to me as president of a software company selling more than $3 million per year in retail packaged software. His expertise was a given.
What happened? That’s my next story: 1994-95: We Saved It.