Most people wouldn't leave a leading Silicon Valley venture capital firm to work at an online start-up that specializes in selling paperweights, mugs, mouse pads, and T-shirts featuring corporate logos.
But that's exactly what Jerry McLaughlin did in 1999 when he left Altos Ventures, with its prestigious Sand Hill Road address, to co-found Branders.com. What the former venture capitalist saw, and what most people missed, was a compelling opportunity to disrupt the promotional products business.
According to the Promotional Products Association International, promotional products—items that companies hand out as premiums or as marketing mementos at conferences and conventions, and which are affectionately referred to by customers and beneficiaries as tchotchkes—constituted a $16.3 billion industry in 2003. A quick look at the North American promotional products industry shows that it is highly fragmented and made up of a network of small to midsize companies specializing in one piece of the promotional products supply chain.
|He sought to address the challenge of customer retention by building a different type of relationship with customers.|
At the heart of this fragmented network are two tiers of distributors. At one end are 20,150 small-scale suppliers with less than $2.5 million in revenue; at the other end are 815 larger distributors with $2.5 million or more in revenue. Most distributors get their products from the approximately 4,000 U.S. wholesalers that import their wares from a variety of manufacturers in Asia.
Historically, promotional products have been sold by individual salespeople who cover a specified territory and function almost like independent contractors. Although the distributors they work for might set them up with an office, a desk, and a phone, the compensation they receive is based largely on commissions. Typically, distributors don't offer employee benefits or health insurance.
In general, a traditional promotional products salesperson needs approximately eighteen months to build up a respectable roster of customers. When a salesperson has successfully grown sales within an assigned geographic area, he tends to turn around and demand higher commissions from the distributor. If the distributor refuses to ante up, there's little stopping the salesperson from taking his customer list and going to work for a competitor.
Customers generally don't develop much loyalty to a specific distributor because the products offered by competing distributors are essentially undifferentiated across the industry. Rather, the charm and charisma of a salesperson is often the critical sales driver.
Higher customer-retention levels, lower compensation costs
McLaughlin believed there was an opportunity within this framework for someone to build a large company that could handle more than just distribution, retain customers better, use its size to leverage economies of scale with wholesalers, and perhaps pass along some of those savings to customers.
He sought to address the challenge of customer retention by building a different type of relationship with customers. With the Internet boom at its height, McLaughlin hit upon the idea of allowing customers to interact with the company via the Internet rather than through a corps of salespeople. This, he reasoned, would solve the problem of salespeople defecting to competitors and taking their customers with them.
The online business model brought added bonuses as well. Sales force compensation eats up 18 percent to 20 percent of traditional distributors' revenues. McLaughlin figured that, if the Internet were the sales interface, compensation costs would decrease and the company could sell products at lower prices than its competitors, even while operating at slightly better margins.
What's more, he reasoned, online operations would speed ordering and delivery.
Another unique advantage was Branders.com's ability to sell from its own catalog. Products usually moved across the industry through a cumbersome and time-consuming sales process that offered few benefits to distributors. A salesperson would show customers a variety of manufacturers' catalogs, each of which offered slightly different variations on the same theme—say, a mouse pad or a bag with the customer's logo on it.
|The challenge for Branders.com will be to continue to execute according to the principles of disruptive innovation.|
Although this gave customers plenty of options, it meant that distributors could not concentrate their sales with a few key suppliers to negotiate for bulk discounts from manufacturers.
Because Branders.com's Web site functions as its catalog, the company determines ahead of time which items it wants to feature, and then it concentrates sales with its key suppliers. This increases Branders.com's ability to guarantee a certain volume of sales to wholesalers while allowing the company to garner bulk discounts. Any savings that result can then be passed along to customers. And customers get their orders more quickly, too.
Navigating rough spots, learning along the way
Operating completely online might seem like an ideal business model, but Branders.com has had to navigate some rough spots since its beginnings.
McLaughlin initially assumed that customers could get what they needed exclusively through the Web site. During the first several months of operation, however, very few registered visitors actually became customers, despite numerous site visits.
Using the small team he already had in place to handle customer service, McLaughlin contacted people who had registered on the site to ask why they hadn't bought anything from the company. The calls were a revelation. Because potential customers were used to some form of human interaction, most people were turned off by the lack of personal contact.
So McLaughlin added call centers to help take customer orders. Though the cost of doing business increased, the company's interface with its customers remained tightly controlled. Today, 15 percent of Branders.com's customers place their orders via the Web site alone. The rest use the phone center sales force.
Having learned some interesting lessons and applied them to enhance the company's business model, McLaughlin once again believes that Branders.com is poised for new growth. The company currently employs 225 people; has 30,000 customers; is profitable; and is growing at a rate of nearly 50 percent per year.
Going forward, the challenge for Branders.com—and for McLaughlin—will be to continue to execute according to the principles of disruptive innovation. Although the company's investors want rapid growth, customer-acquisition costs could put Branders.com's low-price business model in jeopardy. McLaughlin and his staff will need to figure out how to keep customer-acquisition costs low even as they adhere to one of the basic principles of disruption: patience for growth and impatience for profit.