Post of the Day
March 31, 1998

From our AOL
Iomega Board


Subject: ZIP on a Chip and Joe
Author: LMartinvog

I've been monitoring these boards for over 2 years but have posted infrequently. My last post was the day after last year's shareholder's meeting (thanks again Bill for the ride out to Roy). I composed the following upon the request of some friends who wanted to 'know' what was going on with IOM. I also wanted to 'know' or at least try to understand the situation in my own terms.

What follows rambles and is not aimed at the experienced board reader but it is my best attempt to come up with some explanations and it pulls from a lot of history here on this board as well as some other company histories. To that end, I think that I've got the story on CPQ mostly right but I'm open to corrections. As to the story on IOM - I'm not a 'dollar smart' on some of my prices and numbers so please forgive - as to the rest of it.....
history will tell.

Once upon a time�..

CPQ was the fastest company in history to make it to $1B in sales until IOM came along. Their PC product in the early and mid 80's was synonymous with quality. Corporations wanted Compaq's and bought them by the carload because of quality. Other lesser-known manufacturers were referred to as IBM compatible 'clones'. I was setting up micro-centers (at Coca-Cola and other places) at the time and all I heard from managers was that they would not trust their PC production to anything other that Compaq or IBM. I found it odd because my friend Art was making PC's in his garage that were as good as CPQ's for 40% to 50% of the price. I know because I bought one for myself and got my friends to buy them also. I had no hesitation about this - I knew that they were every bit as good but the purchasing managers in large corporations were still not convinced. Looking back, the fact that Art was making these PC's at a reasonable profit pointed to a sea change was happening in PC's - namely the components that make up a PC were becoming commodities.

If I remember correctly, the founder of Compaq at the time was then its CEO. I cannot remember his name and I really wish that I could because it would make reading this story much easier. This guy was dedicated to quality and he shaped CPQ's image as one of a quality PC provider at a premium price. It really worked throughout the 80's. However, one member of CPQ's BOD saw this commoditization also and he commissioned a study to prove to himself that CPQ could also build the same quality PC's for much much less. CPQ's board presented the findings of the study to the founder and president but he refused to let go of the 'quality image at a premium price' concept. The BOD replaced him and put in another guy who managed CPQ's costs down and still maintained the quality and brand name image. This made big news at the time. My point here is that the founder of CPQ took the company as far as he could - he had an image and he shaped CPQ in that image but he could not adapt.

I think that there are significant parallels for IOM. Kim Edwards took IOM from $150MM to $1.2B faster than CPQ and, more importantly, by selling items that retailed, on average, for $150. (CPQ's average item selling price in the 80's was about $3,500) - IOMEGA as a new brand name was born and the ZIP drive was a huge success for consumers while the Jaz drive was a huge success with various corporate and industry segments. Edwards used the Zip's success as marketing 'pull' to get OEM's (IBM, CPQ, Dell, Gateway, etc) to offer ZIP as an add-on. Originally, the price of a ZIP was estimated to be about $45 - $50 to an OEM or $90 - $100 to the consumer - about 5% of the cost of a typical computer about 2 years ago. The goal was simple but profound - replace the floppy. Recently another PC based sea change has occurred - the price of computer parts has dropped precipitously and a PC is now under $1,000 and sometimes approaching $700 to $800. Everybody except Dell is scrambling to adjust to the inventory and marketing implications of this and there is currently a downturn in PC sales as the next wave of PC buyers is sought and courted. The ZIP at $75 to $100 is now anywhere from 10% to 15% of the price of the computer - a significant percentage of the price especially to a new purchaser. Edwards saw this and his answer (as stated in the Q4 '97 conference call) was to launch a $100 MM advertising campaign to get that new computer buyer to buy a ZIP drive. Wall Street didn't like it and I think someone on IOM's BOD also did not like it. Edwards was proposing a 'push' marketing strategy, which was much more costly than his former, somewhat self-financing, 'pull' strategy. I am no marketing expert but it seems that 'Push' strategies work well if the market is mature and you are trying to gain market share. Coke, Pepsi, Intel, McDonald's etc. are continually pushing their product and differentiating themselves. IOM has no one to differentiate themselves from, therefore they are pushing on the proverbial string. My next door neighbor Joe wants to buy a new computer but can't find a killer application (read 'reason') to buy one. If Joe is ever convinced to buy a PC it will be because he found something that he likes out on the Web and believe me he will be sensitive to another $75 to $100 for a ZIP drive for a computer that he has just convinced himself to buy. OK now let's digress for a moment and take a look at our man KE.

After following this stock almost daily for over 2 years, I have good reason to believe that KE is a marketing and advertising guy period plain and simple (duh). He started out by getting that company over in London to help him design the ZIP drive and everything he has stood for was rooted in marketing and advertising. And has he done it well? Ask anybody in or even moderately related to the computer industry and they will most probably know of the ZIP drive. However, as we all know, he has a tin ear for Wall Street and he also has a tin ear for production and for the amount of effort it takes for new product introduction. Everything that has had to do with production and development was a struggle for him. I remember at last year's annual meeting asking him about the status of the 'ZIP on a chip' - the much discussed initiative to reduce the 8 or so chips on a ZIP drive to a single chip. Supposedly Motorola, TI, and Intel were jointly working on this (then Intel dropped out and nobody ever heard of it again). I remember his answer like it was yesterday. "While the cost of the chips is the single largest component of the ZIP drive, �.the ZIP on a Chip is a long way off�." - as if he did not want to even address it and it was not on his radar screen. In other words, the single largest component for getting a ZIP drive down to 5% of the cost of a computer (i.e. making it attractive for Joe) was not even on his agenda or was a very low priority. KE's bias for marketing is very clear and it served him and IOM extremely well - until recently. I contend that if KE had indicated that IOM was going to give the ZIP on a chip the priority this year and that his target production price was $10 - $15, the stock would have gone from $13-14 to $16-18 instead of to $9 then to $7. This indicates that I believe that it can go there again if they get the right focus.

Digress with me for a minute and go back to Henry Ford - he had the idea that a low priced car would be purchased by everyone. I am not sure, but I'd bet that he did not go out and spend $1 on advertising until he had the assembly line concept down and cars were being produced that people could afford. People saw that cars were affordable and started to buy them. I realize that this analogy is weak but it seems that our industries must establish themselves first and then go advertise. KE had a unique situation in trying to unseat an incumbent (the floppy) with a surprise attack and his strategy was right at first - get a sexy product and get a foothold against the enemy - (just like the Compaq founder and CEO got a foothold for CPQ with quality over cost). However, KE took a significant wrong turn (unlike the CPQ guy who took no turn) - he, in effect, 'danced once too often with the one who brung 'im' - good ole Miss Marketing. He should have dumped her and got a new girlfriend - one who could mind the household (production), drive down the budget, and make friends with the neighbors (Wall Street). KE, in effect, confused marketing with advertising. He thought he could advertise his way to Joe. No way, what Joe needs is someone on the other end of the phone or at the retailer or his next door neighbor when he orders the computer telling him that he should spend an extra 5% ($40 - $50) and get a ZIP drive that works efficiently and effectively. Better yet, just build it into the computer for Joe as a competitive advantage; after all it only cost the OEM $20 or $25. As many have said, the tie ratios will take care of themselves.

IOM and going forward? I somewhat agree with many who say that the floppy replacement may take years and it may be fragmented amongst many players. However, I also know that IOM has 80% of the market and I also believe the IDC estimates that indicate that the removable storage market will conservatively grow at 25% to 30% per year over the next 5 years. I also believe that IOM still has about a 6 month to maybe 1- year window to clean up the production mess. I think that the single biggest component of sewing it up is getting the internal ZIP to a sale price of $40 to $50 which depends upon IOM's ability to produce it for about $10-$15 which depends upon getting 'ZIP on a chip' (at about $3- $5 to produce the chip). So, I am a holder now. If they bring in a technically oriented Edwards replacement (engineer or chips lady or production somebody) to run the company then I'm happy. If they bring in one of the division heads from Coke or Pepsi then I am gone.

Guess what question I plan on asking this year at the annual meeting�if there is even a Q&A session.

In summary - I agree - ZIP is it - get its guts on one chip at almost any cost.

In addition:

- Keep up the current product development especially with Clik! albeit at a lower level - no new products for 2 years; Joe is more likely to buy a digital camera with a Clik drive right now than a PC.

- Keep some level of organized advertising but scale it way back

- Get somebody who can really manage the company's finances and who can court Wall Street; Sorry Len, you've got to go also;

- Get a systematic plan to reduce the cost and sell price of the ZIP disks;

Some will ask what is the real price elasticity for Joe? I reject the premise - get the drive to its lowest cost period.

Now the really big question - why did it take KE's resigning to bring me to these revelations? Complacency I guess.

Thanks to all here for their efforts. The signal to noise ratio here is bad at times but it is well worth it to read some of the more reasoned analysis.


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