■■

In this issue:
■ Learn...
Blueprint to a Billion
how you can turn a big idea 7 Essentials to Achieve Exponential Growth
into a billion-dollar business
that generates exponential
growth and returns, no by David G. Thomson
matter what industry you're
in or how the economy is
performing. A summary of the original text.

■ Implement...
a winning approach based
on the success patterns of THE BLUEPRINT THESIS Of the 7,454 companies
America's 387 highest that have gone public since
growth companies, includ-
ing Microsoft, Google, The odds are one in 50 that 1980, more than 2,000
Staples, Genentech, Home an idea becomes a busi- have already gone out of
Depot, and Starbucks. ness, one in 20 that a fund- business. Of the survivors,
■ Discover... ed business sees an IPO, only 387 have grown to $1
how to create and sustain a and one in 20 that a public billion in revenue. These
breakthrough value propo- company achieves $1 billion
sition and exploit a high- Blueprint Companies have
growth market segment. in revenue. made an enormous
impact: They represent
■ Maximize...
your revenues by establish- This means that the odds just 5 percent of the U.S.
ing deep relationships with a of turning an idea into a companies that went public
limited number of valued billion-dollar business are since 1980, but they
customers who don't just buy
from you, but actually sell a staggering one in 20,000. accounted for 56 percent of
for you. employment in 2005 and
■ Leverage...
How can you improve your 64 percent of market value.
“big brother” alliances odds? Winning companies
between large and small follow success patterns that The success of the
companies, create a manage-
ment team based on inside- produce their exceptional Blueprint Companies makes
out leadership, and recruit performance. These firms it clear that they are the
“essentials experts” to the are known not only for heart of America's innova-
board of directors.
their innovation, but also tion and growth. They
for the exponential growth include such well-known
■■ of their revenues and innovators as Microsoft,
Volume 15, No. 2 (2 sections). Section 1, March 2006
returns, regardless of the Cisco, Google, Starbucks,
© 2006 Audio-Tech Business Book Summaries 15-5. state of the economy or the eBay, and Home Depot,
No part of this publication may be used or reproduced
in any manner whatsoever without written permission. business climate. and lower-profile compa-
To order additional copies of this summary, reference nies such as Performance
Catalog #3061.
Foods, Fastenal, Tractor Supply, and Columbia Sportswear. Unless their unique
approach is utilized, the odds are higher for business teams to be part of the 95 percent
that fell short than the 5 percent that reached the top.

BLUEPRINT COMPANIES ARE AMERICA’S GROWTH ENGINE

Source: Standard & Poor’s Compustat, Blueprint analysis

Fortunately, you can change your odds by understanding the success pattern of this
select group of high-performing companies. The Blueprint Companies share 7
Essentials for creating exponential growth.

These 7 Essentials are:

1. Create and Sustain a Breakthrough Value Proposition.

2. Exploit a High-Growth Market Segment.
3. Use Marquee Customers to Shape the Revenue Powerhouse.
4. Leverage Big Brother Alliances for Breaking into New Markets.
5. Become the Masters of Exponential Returns.
6. Create a Management Team Based on Inside-Outside Leadership.
7. Recruit “Essentials Experts” to the Board of Directors.

Let's examine each of these Essentials in detail.

■■

1. CREATE AND SUSTAIN A BREAKTHROUGH VALUE PROPOSITION

The starting point for any company is its value proposition. What fundamental bene-
fit is it going to offer its customers? Some are obvious, such as "things go better
with Coke." Every one of the Blueprint Companies started with a compelling value
proposition. But these companies had breakthrough value propositions.

A breakthrough value proposition requires more than a breakthrough product or ser-

vice. The innovation must be aligned with the unmet needs of customers. Only when

2 AUDIO-TECH
the two match does a breakthrough value proposition burst onto the marketplace.
Blueprint Companies create breakthrough value propositions by asking three critical
questions:

• First, what market segments are we addressing?

• Second, who are our targeted customers?
• Third, what breakthrough benefits are we delivering?

Blueprint Companies can create new markets, redefine existing markets, or optimize
mature ones. But in each case, they are aligning the value of their innovation to the
unmet needs of customers. Genentech created a new market in biotech products.
Starbucks redefined an existing market for coffee. And JetBlue optimized a mature
market in airline travel. In each case, the leaders of these companies had to act when
the time was right.

Targeting the customer means knowing who has those unmet needs. Blueprint
founders understand that there are people on the other end of their value proposition.
Tom Stemberg, the founder of Staples, interviewed small businesses and played the
role of a purchasing agent to identify people's unmet needs.

Blueprint Companies also recognize that there are two kinds of benefits a company can
offer: functional and emotional. A high-order benefit offers both. For example, JetBlue
offers functional benefits, such as on-time departures and arrivals, as well as non-stop
travel. But it also offers the emotional benefit of enjoyment, comfort, and peace.
Together those qualities create a breakthrough value proposition.

Breakthrough value propositions come in three general categories:

1. Shapers of a new world

2. Niche shapers
3. Category killers

Shapers of a new world include companies that create entirely new markets or that
fill gaps in existing markets. Among the firms that created new markets are Amgen,
which discovered new drugs; and Cisco, which invented the routers for the Internet.

Other companies shape a new world by filling a critical gap, as Broadcom did.
Broadcom had its computer chips in 80 percent of America's cable modems and TV-set-
top boxes by the late 1990s. Along the way, its revenue growth rate passed by Texas
Instruments and Intel, among others. How did the founders do it? They worked with
their customers to define the need, and then they worked toward fulfilling that need.
They asked their customers, “If we give you this, is this what you want to buy?”

And Broadcom did just that — it gave its customers what they wanted. The result
shaped a new world, which we now take for granted — the world of high-speed
communications for Internet access.

The second category in creating breakthrough value propositions consists of niche

BUSINESS BOOK SUMMARIES 3

shapers, such as Starbucks. The company sells not just coffee, but the experience of
Italian café culture. When Howard Schultz opened his first shop in 1986, he shaped
the market niche that is now occupied by his 8,500 stores.

The third way to create a breakthrough value proposition is to become a category

killer. These companies come after the world shapers to optimize their market,
either by cutting prices or improving quality. Wal-Mart and Southwest Airlines are
well-known examples. The strategy for becoming a category killer is to identify a grow-
ing market where the customer is underserved and which has adequate margin. Then
build a more efficient value chain for cost and price advantage. This formula allows
category killers to capture 10 to 20 percent of the incumbent's market share.

Value players, such as JetBlue, Home Depot, and Staples, are offering the powerful
combination of low price and good-enough quality and are capturing the hearts and
wallets of consumers in the U.S. today.

Surprisingly, only 57 percent of the Blueprint Companies are shapers of a new world.
The rest are niche shapers (33 percent) and category killers (10 percent), which account
for 49 percent of the market value created by the top companies. In short, those com-
panies did not have to be in the position of having to create the next wave of innova-
tion in order to create a billion-dollar business. There are more opportunities to create
businesses than you may think! In addition, the market value of the world-shaping
companies (51 percent) was not significantly higher than the others. It is all about
achieving returns, not the source of your big idea.

Once the Blueprint Company has identified the right value proposition, the next
Essential is to find the market segment that offers the greatest potential for growth, as
we will discuss next.

■■

2. EXPLOIT A HIGH-GROWTH MARKET SEGMENT

Since the tech boom of the 1990s, it has become natural to assume that the greatest
number of Blueprint Companies came by way of routers, high-speed chips, and hard
drives. But it's not true, and that fact is one of the many compelling surprises to come
out of the Blueprint study. The specialty retail store industry is far and away the
hottest industry, with property and casualty insurance ranked second.

With the profile of eBay, Priceline.com and Amazon.com, you may be thinking that the
Internet retail industry was near the top of the list. Again, not true. Only these three
companies made it to $1 billion in revenue in this industry. America's innovation
occurs most frequently in large, mature industries.

Publicly traded specialty stores accounted for $187 billion in revenue and reside in the
top 15 percent of industries by size. The biggest ones are AutoZone, AutoNation, Office
Depot, and Staples. They follow the niche shaper and category killer formulas.

4 AUDIO-TECH
TOP BLUEPRINT SPECIALTY STORES

Source: Standard & Poor’s Compustat. Blueprint analysis

But while these giants base their value proposition on price, convenience, and service
— or some combination of the three — others near the top are actually providing high-
er value in order to achieve higher margins. Williams-Sonoma, which owns Pottery
Barn, West Elm, and Hold Everything, is one such company.

Williams-Sonoma started as a niche player. In 1978, Howard Lester, the company's

chairman, noticed that there wasn't a national kitchenware retailer, just about 7,000
small cookware shops. Williams-Sonoma not only sold cookware, it defined a lifestyle
and appealed to people's aspirations for a better one. It aimed at affluent customers
and high-end brand names.

Lester knew that if he could establish 50 stores quickly across the country, he would be
impossible to catch. Along the way, he bought Pottery Barn from Gap to fill out the
lifestyle offerings. Then he completely redefined Pottery Barn to make it a standard of
quality. Today Williams-Sonoma is a $2.7 billion retail powerhouse.

On the other hand, the property and casualty insurance industry is even bigger, pulling
in $271 billion in 2004. Among the reasons for its success is increased sophistication
of sales and better focus on the customer. Automated technologies have reduced costs
and improved service.

One Blueprint Company, State Auto Financial, uses a three-point concept for its expo-
nential growth:

• First, it makes money from underwriting operations. A team of actuarial experts

looks at trends and determines price levels for the company's various products.

BUSINESS BOOK SUMMARIES 5

 Every second week, senior management reviews the pricing structure and adjusts
it, if necessary, to ensure that the company can cover the cost of claims and
expenses, and make a profit for its shareholders at the same time.

• Second, the company has a low price structure. High efficiency keeps expenses low.
The company takes advantage of information technology to eliminate paper,
redundancy, and errors.

• Third, State Auto achieves revenue growth, both through organic growth, and
through mergers and acquisitions. The firm has 3,200 agencies with 22,000 agents
serving them. It now operates in 28 states, up from 17 at the time of its IPO in
1991. It's also diversifying from mainly personal lines of insurance to increasingly
commercial lines for small-to-medium-sized businesses.

State Auto achieved billion-dollar revenues in 2003. It is one of only 15 insurance com-
panies that have earned A.M. Best's highest rating every year since the rating system
began in 1954.

From these examples, we can derive five general lessons about exploiting a high-
growth market segment:

1. Most of the Blueprint Companies are growing in mature markets, not newer
industries, such as Internet retail. This is because those mature markets are huge
and include things that everyone needs, such as auto parts, furniture, and finan-
cial services. Other top leaders include health care and real estate. A big market
with unmet needs is the doorway to exponential growth.

2. Top Blueprint Companies use best management practices and technologies to

stay close to their customers. Even large insurance companies use the latest in
market research and product innovation to develop niche products for specific mar-
ket segments. But it's not just technology — it's people, too. These service compa-
nies use a business model that can tolerate more and more locations so that the
company can be physically close to the customer. Through this practice, they
maintain an aggressive sales culture.

3. Blueprint Companies extend their brand into multiple product lines or ser-
vice offerings. They determine product line extensions by identifying unmet
needs that are adjacent to their core value proposition. For example, Williams-
Sonoma created a home furnishings portfolio to propel its growth. The portfolio
includes affordable prices at Pottery Barn; premium prices at Williams-Sonoma;
children's furniture at Pottery Barn for Kids; minimalist stylings at West Elm; and
storage solutions at Hold Everything. These offerings target different market
segments at different price points.

4. High-growth companies partner with their suppliers to lower the cost of product
delivery, and for product differentiation. As large retailers became technologically
advanced, they drove prices down, not just through higher volume, but also by
becoming technically savvy with their suppliers. For example, AutoZone and other

6 AUDIO-TECH
 retailers link with their suppliers electronically, eliminating paperwork, and use
radio frequency identification tags for tracking. This is the key to everyday low
prices at many category killers.

5. Blueprint Companies import talents and lessons from adjacent industries.

Fifth Third Bankcorp transplanted the aggressive sales style of the insurance
industry into the more conservative banking culture. The resulting hybrid led
to exponential growth with a highly conservative control over costs, which fur-
ther enhanced the bottom line. Likewise, Staples adopted the principles of the
supermarket to the selling of office supplies, including shopping carts and wide
aisles.

With these important lessons in mind, let's see how the next Essential, relationships
with customers, can help shape and propel the exponential growth formula.

■■

3. USE MARQUEE CUSTOMERS TO SHAPE THE REVENUE POWERHOUSE

Blueprint Companies don't achieve their billion-dollar revenues simply by increasing

the number of transactions or even by selling harder, though they may do both of those
things.

The secret to their success is this: They secure deep relationships with a limited
number of valued customers who become the rising tide for exponential
revenue growth. These special relationships account for a disproportionate share of
revenues at the top companies. These customers didn't just buy from these up-and-
coming Blueprint Companies — they sold for them!

For one thing, in the early growth stage, these customers give a company credibility
that can't be found elsewhere. When Terry Eger, then Vice President of Sales at Cisco,
was starting out in the late 1980s, he was in a very odd position. He was trying to sell
routers to people who had never heard of them and didn't know what they did.
Fortunately, the Hewlett-Packard 3000 and 9000 systems could only connect with that
product. Because of that one application, Cisco landed a contract with Boeing, then
with Motorola.

But Eger nearly lost another deal with Solomon Brothers, who wanted to choose his
competitor, Vitalink. Vitalink's relationship with Digital Equipment Corporation made
it possible to repair a breakdown within four hours. When Eger heard this news on a
Friday, he knew he could do better and asked Solomon to wait until Monday.

Over the weekend, he and his engineers tested their system and found that even in the
worst of circumstances, the longest it would go down would be 26 seconds. Eger won
the order, and Cisco's relationship with Solomon propelled it into the big leagues.

Boeing, Motorola, and Solomon are examples of Marquee Customers. Marquee

Customers are people or companies with such sparkling reputations that they give the

BUSINESS BOOK SUMMARIES 7

company they do business with instant credibility and status. But they don't have to
be businesses. They can be consumers, too. EBay's Marquee Customers are the
Powersellers. You will find them clearly identified on eBay and are active in eBay's
Voice of the Customer programs.

Marquee Customers help companies in three ways:

• First, they test and deploy the product. If something is wrong, they will say why,
and if it is good they will place an order.

• Second, they help co-develop the value proposition. They can offer valuable
feedback on new features and improvements to make a better fit with a larger mar-
ket. To keep its site at the cutting edge, eBay recruits its best customers to make
decisions on new features.

• Third, they not only tell their peers, they often sell to their peers. The best
customers are an extension of the company's sales force. This grass roots selling —
or viral marketing — has a powerful synergistic effect.

To create the Revenue Powerhouse of exponential revenue growth, the Blueprint

Companies follow a four-step approach:

THE REVENUE-POWERHOUSE FRAMEWORK

• First, they secure a customer beachhead with a champion who will buy their
product for the first time.

• Second, they capture the mind of the customer with intangible benefits.

• Third, they develop Marquee Customers.

• Fourth, they maximize customer life-cycle revenues by developing a unique

8 AUDIO-TECH
 revenue-building approach.

Let's take a closer look at these four critical activities.

To secure that first influential Marquee Customer, you don't need to have a great prod-
uct. It just has to be good enough to meet the customer's needs. From there, you can
continue to shape and improve it. Sometimes the quick and dirty solution wins.

As soon as that beachhead is established, quickly begin to develop a long-term

relationship using these three tactics:

1. Uncover a latent or unmet need by asking a lot of questions. Needs always exist, but
they aren't always immediately apparent. Cisco discovered Solomon's unmet need:
to have its system up 100 percent of the time.

2. Identify an innovative solution to that unmet need. JetBlue did just that when it
installed small TV screens on the back of each seat. It then went a step further and
allied with two companies that had satellite TV service.

3. Implement a vision. Blueprint Companies don't just look for a transaction. They
fulfill a higher-order need, which tends to maximize revenues over the years. When
Cisco gained Motorola as a customer, its job was to connect computers at its Austin,
Texas, facility. But Cisco knew that Motorola had more than 100,000 employees
spread across four campuses in four different states. Cisco had a vision for a
Motorola global network.

Second, Blueprint Companies sell more than products; they capture the mind of the
customer with intangible benefits. They are guided by a mission and have a big pic-
ture that electrifies the brand and excites customers. This vision provides a compelling
emotional benefit, a roadmap of new products to come, and the company's potential to
serve a greater good.

These big ideas are synthesized into a crystal clear concept that is aligned with an
intangible benefit. That, in turn, creates permission from customers to rapidly extend
and add new products and provide endorsement to other customers. For Google, the
big idea is "to organize the world's information and make it universally accessible and
useful."

The third critical activity of Blueprint companies is to secure Marquee Customers.

To appreciate how important this is, consider the case of Cisco. Its first sale to a
Marquee Customer was worth a million dollars. As the relationship developed, the cus-
tomer increased purchases at an exponential rate, ultimately totaling hundreds of
millions.

So how do you find a Marquee Customer? The challenge has two parts.

The first part is identifying potential Marquee Customers. Marquee Customers are the
thought leaders of the industry. These may not be the largest companies, but they are

BUSINESS BOOK SUMMARIES 9

well-respected and recognizable. Of course, you should consider the industry giants as
well.

For example, a supplier for Wal-Mart must be setting a standard that is respected for
price, quality, and performance. In addition, look to Blueprint Companies in the
making, because they become the next generation of Marquee Customers.

The second part to the problem is to make friends with the friends of Marquee
Customers. Determine who their advisors are. Get to know them and ask for a
recommendation. Go to the professional associations to meet their executives.

Finally, the fourth thing Blueprint Companies do right is to develop a unique

approach to revenue building. Microsoft exemplifies the seven variables involved
in maximizing customer life-cycle revenues.

Life-Cycle Revenues =
Product Scalability X
Revenue-per-Unit X
Number of Customers X
Purchase Frequency X
New Product Extensions X
Geographic Coverage X
New Lines of Business

The first variable is scaling. Microsoft launched MS-DOS 1.0 in 1981 with IBM as its
Marquee Customer. It scaled up to Windows 2.0 in 1987, 3.0 in 1990, and followed with
Windows 95.

Revenue-per-unit is the second variable. If the price is low, volume is critical. The abil-
ity of the sales force to negotiate the best price per unit is a key to maximizing gross
margins.

The number of customers is the third variable. This can have a broad range of out-
comes. For Ciena, a maker of optical equipment, there were only two customers, Sprint
and WorldCom. Microsoft, by contrast, had millions of customers. Success is measured
by share of customers.

The frequency of purchases is the fourth variable. With low-priced products, customers
must make many purchases over time. By focusing on a diversified product line that
could be bundled, Microsoft increased the frequency of purchases and the revenue per
customer. In addition, it went after Marquee Customers with large installed bases of
PCs. Telecom Australia, for example, ordered Windows for its 25,000 computers.

The fifth variable is new product extensions. Maximizing the portfolio increases the

10 AUDIO-TECH
number of customers and the revenue per customer. In 1989, for example, Microsoft
shipped 256 localized versions of software in 16 languages.

The sixth variable is geographic coverage. This increases the customer base. In 1989,
Microsoft earned 57 percent of its revenue from domestic sources, with the remainder
being international.

The last variable is new lines of business. This will grow revenue and create pull for
the core business. Microsoft started as early as 1983 introducing Windows, Mouse, and
Word. In 1987, it acquired Forethought Inc., the developer of PowerPoint.

In each of these seven ways, Microsoft and other Blueprint Companies have maximized
the life-cycle revenues from their Marquee Customers.

Once you have acquired and developed your own Marquee Customers, you have to
begin using them as a source of power for revenue growth. To show how to do this, we'll
now examine how these alliances work.

■■

4. LEVERAGE BIG BROTHER ALLIANCES TO BREAK INTO NEW MARKETS

The complement to Marquee Customers is a Big Brother-Little Brother alliance. In

these relationships, a bigger company helps a smaller one, provides credibility, and
leads it to Marquee Customers.

The alliance is a two-way street. Big Brothers also need Little Brothers to help them
remain on the cutting edge of innovation.

Consider Microsoft, which is the top-ranked Blueprint Company in the study, with
growth to the billion-dollar mark over a six-year time line and astounding growth both
before and after. Its most famous and significant alliance, of course, was as a Little
Brother to IBM.

In the 1970s, Bill Gates was a young man with a small company in Redmond,
Washington. There was precious little software for the new 8086 chip. But another
software designer, Tim Patterson, had already written an operating system that
worked.

Meanwhile, IBM was attacking the PC problem and recognizing that it would have to
outsource both the operating system and the programming languages. It went for the
standard of the time, called CP/M; but the creator of that operating system, Gary
Kimball, was late writing upgrades for the 8086 chip and wouldn't negotiate terms that
IBM liked.

At that time, the little company called Microsoft had already provided IBM with its ver-
sion of BASIC and a few other languages that ran on other chips. So the engineers at
IBM already knew Gates and his partner, Paul Allen. They asked if the young team

BUSINESS BOOK SUMMARIES 11

could provide an operating system for the 8086. Gates hastily went to Tim Patterson
and bought his operating system for $50,000.

In October 1981, the IBM Personal Computer was introduced, running Microsoft's
software — then dubbed PCDOS 1.0. And the rest, as they say, is history.

AOL was eBay's Big Brother. Genentech had Eli Lilly. Yahoo had AT&T WorldNet. In
every Blueprint Company, you can look back and find such a Big Brother-Little Brother
relationship.

These alliances fall into two broad categories: business-model and revenue-centric.

Business-model alliances optimize the business model. They may do this through
supplying low-cost products or services, filling critical gaps in the offering, or creating
channels to market.

Revenue-centric alliances focus on the customer and form a suite of alliances that
accelerate revenue growth in various ways. For example, Cisco expanded geographi-
cally, entering into alliances with British Telecom, Siemens in Germany, and Olivetti
in Italy, to increase its customer base.

However, one of the findings of the study is that there are a limited number of poten-
tial Big Brother partners out there. Within each segment of the software industry, for
example, there are only three or four large providers who can take on that role. And
each one can take on only so many Little Brothers, who can take up a lot of the larger
company's time.

That's why navigating this tricky relationship requires dedication on both sides.
Procter & Gamble has mastered the techniques better than most. In fact, A.G. Lafley,
the President and CEO of P&G, has said that he wants to source half of the company's
innovation externally.

In addition, P&G has an External Business Development division that does nothing
but build value through taking the company's intellectual assets outside and bringing
external innovation inside. That, naturally, leads to Little Brother alliances.

Here are the elements for a well-structured alliance agreement:

• First, choose the right agreement. It is not always desirable to invest in a for-
mal contract before the value of the partnership is clear to both parties. Choose a
type of agreement that acknowledges that uncertainty, and outlines the nature of
the contributions expected from both sides.

• Second, avoid granting exclusivity, but always push for getting it. Hedge
your bets by relying on multiple partners. Allow market forces to define de facto
exclusivity. Notice that this is exactly the sort of agreement Gates got from IBM.
He could sell his operating system elsewhere, but IBM was locked into his product
by design.

12 AUDIO-TECH
• Third, use equity to encourage mutual performance. Contrary to popular
belief, equity does not guarantee performance. Think of equity as an incentive one
may pay out in the long run if the partnership is effectively executed.

• Fourth, commit business unit heads, along with the CEO of the small com-
pany, to champion the alliance. Senior executives on both sides should be
champions of the partnership. Their names should be on the agreements.

• Fifth, develop an exit strategy. This includes benchmarks on performance or

market conditions. There are three basic paths to the exit: (1) the big company
may buy the smaller company; (2) the big company may buy the intellectual prop-
erty; or (3) the two companies may either grow together or grow apart. Effective
contracts include provisions for all three.

■■

5. BECOME THE MASTERS OF EXPONENTIAL RETURNS

Unlike companies that fail, Blueprint Companies expect to make a profit. In fact,
they demand it early. There are three fundamental rules of market value creation:

1. The companies that create the highest market value are the ones that create the
greatest spread between return on invested capital and the cost of capital.

2. Companies that create high revenue growth give the management team the oppor-
tunity to reinvest at the high rates of return being generated by the business.
These rates are significant, because they're available only to the company, not to
the market in general. This allows the company to create value that is unavailable
to ordinary investors.

3. The greatest risk to the business is sustainability. Companies with high market
share and high returns have the greatest probability of success.

If all this sounds like common sense, perhaps it is. On the other hand, more than 25
percent of the 7,454 companies that went public since 1980 did not follow those simple
rules, throwing good money into a company with negative returns until the capital ran
out.

Cisco provides a showcase of the three rules. The company grew from $27 million in
1989 to over $1 billion in 1994. Its earnings margin averaged more than 30 percent
during that time. It also delivered incremental profit and free cash flow growth rates
in excess of 300 percent. Even while acquiring numerous companies on its way to a
billion dollars, Cisco maintained an average return on invested capital of 35 percent.

Although, as mentioned previously, specialty retail dominates the Blueprint Company

list, high-tech dominates the highest market value. In other words, those companies
are most valued by shareholders. There are four key principles to creating this
superior value:

BUSINESS BOOK SUMMARIES 13

• First, create attractive gross margins early. High-tech companies achieve mar-
gins of 60 percent or better early on, and remain at that level. At Cisco's start, its
margins were 58 percent and were on their way to 69 percent.

• Second, contain expenses to achieve 20 percent or better earnings before

interest, taxes, and depreciation. High-tech companies spend selling, general,
and administrative expenses (SG&A), and R&D costs equal to the difference
between the gross margin and that 20 percent.

• Third, become cash-flow positive early. Blueprint Companies do not wallow in

red ink. From about the time they achieve $20 million in earnings, they have
positive cash flow.

• Fourth, utilize incremental gross margins to self-fund incremental invest-

ment. Blueprint Companies maintain higher than average gross margins, which
they use to self-fund a higher level of growth toward the billion-dollar mark.

Turning your business into a powerhouse of exponential growth requires a different

kind of management. Let's take a look at what inside-outside leadership means.

■■

6. CREATE INSIDE-OUTSIDE LEADERSHIP TO LEAD THE EXECUTION OF

THE 7 ESSENTIALS

In 1994, when Jerry Yang and David Filo created a Web page navigator as students at
Stanford University, they were inexperienced kids. But a year later, their Web site and
search service had become so popular that it outgrew Stanford's computer.

Fortunately, Marc Andreessen invited them to put their system on his big computer at
Netscape. As the enterprise rapidly grew into a real business, Yang and Filo realized
that they didn't know how to handle it.

They recruited Tim Koogle as CEO, and he hired Jeff Mallett as COO. Together, the
duo made the company one of the few internet companies to turn a profit in the 1990s.
The enterprise was called Yet Another Hierarchical Official Oracle — and the name
was shortened to Yahoo!

Dynamic duos are the stuff of corporate legend. Sears needed Roebuck, Roy Disney
needed Walt, and Hewlett needed Packard. In fact, Blueprint Companies do spring
from such pairings. And in addition, for the duo to be dynamic, one of the pair has to
excel in the outside part of the effort — the marketing and sales — while the other has
to be the insider — keeping operations humming along and developing new products.

Cisco, eBay, Nike, Starbucks, and many others have followed the same pattern of
Blueprint leadership.

Blueprint leadership has three dimensions:

14 AUDIO-TECH
• The first is a focus on relationships and products. One member of the dynam-
ic duo is focused on building relationships with Marquee Customers, Big Brother
alliances, strategic investors, board members, and outsiders — such as other
Blueprint CEOs, suppliers, and community leaders. The other person is focused on
product development, processes, and systems within the company.

• The second dimension is the drive to innovate and explore. While one person
manages the internal structure, the other is exploring and shaping opportunities.

• The third dimension of Blueprint leadership is the ability to manage the 7

Essentials simultaneously. This requires a lot of juggling to execute each
Essential, which in turn requires a particularly talented team.

In general, Blueprint leaders do not share a common background. They come from all
walks of life, from college dropouts to the leaders of large companies. But typically,
these inside-outside leaders stay with the company all the way to the $1 billion mark.

Another trait they share is that they are good, consistent communicators. This
includes having a clear statement of mission and values, and communicating it again
and again with each new message. These are communications of both words and deeds.
Consistency is especially tested when the company is under stress — and that stress
can come from either a threat or an opportunity. Demonstrating consistent values at
such times reinforces the leaders' values.

In doing so, leaders strengthen themselves and their entire team as well. They shape
their company's destiny in the face of intense uncertainty. Blueprint leaders feel a com-
fort level with problems that seem to baffle others. They can see patterns — of
Marquee Customers, of Big Brother alliances, and of linkages among the 7 Essentials
— that help make sense out of what may at times seem like chaos.

From that sort of strength and clarity — and the talent of the team — comes the
ability to manage the 7 Essentials simultaneously.

This strength is supported externally by the board of directors, as we will explain in

the next part of this discussion.

■■

7. RECRUIT “ESSENTIALS EXPERTS” TO THE BOARD OF DIRECTORS

Blueprint Company boards are heavily weighted with alliance partners, customers,
and CEOs who have themselves run billion-dollar businesses. Those boards are there-
fore an extension of the company's own strategy and a reflection of the management
team.

Of the companies that reached $1 billion in revenues within four years, 60 percent had
an alliance partner on the board, while 30 percent had board members who were cus-
tomers. The ratio was reversed for the companies that took 12 years to grow to $1 billion

BUSINESS BOOK SUMMARIES 15

in revenues. In addition, CEOs from other Blueprint Companies were represented time
and again.

The boards were quite balanced in terms of structure. The average number of direc-
tors was nine, with customers, alliance partners, community leaders, and CEOs from
other large companies counter-balancing the investors and management team.

Typical of these boards was eBay’s, which recruited Howard Schultz of Starbucks
and Scott Cook of Intuit, two leaders of other Blueprint companies. These external
members of the board provide cross-industry experiences that can greatly benefit
the company.

By contrast, companies with boards dominated by investors tended to struggle. One of

the reasons is that they look at the short-term returns and act as a surrogate manage-
ment team. In short, creating and maintaining a trust-based relationship between the
board and the management team is paramount in getting a company to the $1 billion
mark.

Now let's examine how to put all the 7 Essentials together to form a powerhouse that
achieves exponential revenue growth with exponential returns.

■■

LINKING THE 7 ESSENTIALS

To achieve $1 billion in revenue, a company has to start with a surprisingly high

growth rate. To reach that goal in four years, the compound annual growth rate has to
be 110 percent. For six years, it has to average 65 percent. And for 12 years, it requires
30 percent. Those are big numbers. What does it take to achieve them?

Compare, for example, Siebel Systems with Onyx Software. The two companies are in
the same customer relations software business and started at about the same time —
Siebel in July of 1993, Onyx in February of 1994.

The seeds for exponential growth of these two companies were sown between 1994 and
1998, prior to the tech bubble. Both targeted the market for sales force automation and
customer relationship management software. Both used Microsoft as a platform. Both
had access to capital. But their stories are very different.

Siebel reached its inflection point — the point at which it broke out to exponential
revenue growth — at three years, and then rocketed to a billion dollars.

Siebel's inflection point came in 1996, at revenues of $39 million, and then it grew at
an astounding rate of 389 percent per year. By 1999, Siebel had achieved $790 million
in revenues, a net income of $122 million, and a market value of $15 billion. The
following year, 2000, it achieved not merely $1 billion, but $1.7 billion in revenue.

Onyx, by comparison, reached its inflection point two years later than Siebel in

16 AUDIO-TECH
1998, and its growth rate was only a third of Siebel's. By 2000, it had peaked at
$121 million with a market value of $407 million.

SIEBEL AND ONYX

Source: Standard & Poor’s Compustat, Blueprint analysis

To see why the two companies, poised for the same trajectory, took such different paths,
we need to examine how they executed the 7 Essentials.

To begin with, the founding teams of the two companies came from different back-
grounds. The founders of Siebel, Tom Siebel and Patricia House, came from Oracle,
with a sales background.

The three Onyx founders, Brian Janssen, Brent Frei, and Todd Stevenson, came from
Microsoft. After developing an internal customer management solution in-house, they
decided to found Onyx.

Onyx bet on Microsoft's Windows NT technology in creating its software. While NT

was the fastest growing platform with medium-sized businesses at the time, larger
businesses ran UNIX and used databases by IBM and Oracle.

Siebel took a different approach. It defined the problem this way: There was no infor-
mation technology in 1993 that dealt with sales processes, marketing, and customer
services. It was an empty field. Siebel began interviewing customers, such as Oracle
itself, Sun Microsystems, Amgen, and Cisco, to find out what they wanted.

The company compiled a requirements list and then developed a product to meet cus-
tomers' needs. It then gave a prototype to those customers to try. The customers used
and critiqued the product, and Siebel adjusted it to meet their exact needs. Then
Siebel's engineers built a system based on that research and testing.

The result was a scalable system that could handle anywhere from 50 to 50,000 sales-
persons. It was multi-lingual and very adaptable to a customer's needs. It freed the
sales force from back-office tasks so they could be out in the field and selling. In an era

BUSINESS BOOK SUMMARIES 17

where sales people were still carrying around scraps of paper and using sticky notes, it
represented a huge savings in overhead costs. Siebel developed the first release of the
product for just $1.8 million in R&D.

Siebel developed an early partnership with Andersen Consulting (now Accenture) that
meant that its system not only ran on Windows NT but also interfaced with IBM's
Universal Database. It recruited its early customers, such as LSI Logic and Cisco, into
the specification process. This ensured that they were happy with the end result and
that they told their friends and colleagues. It turned into a viral marketing campaign.
Everyone wanted it. Siebel had successfully executed on Essential number one: the
big idea.

On the second Essential — exploit a high-growth market — both companies had

potential access to the same customers. But they chose differently. Onyx targeted
medium-sized businesses. It was depending on the growth of Windows NT as an agent
of its own growth. Siebel targeted Fortune 500 corporations with a flexible view of
unlimited expansion and adaptability.

Essential number three is to recruit Marquee Customers. In 1997, Siebel's revenue

tripled based on sales to Marquee Customers such as Siemens, Compaq, and Schwab.
It then added Ford, Bank of America, and GE Capital, among others.

Onyx, too had its Marquee Customers, such as Cincinnati Bell and the Seattle
Seahawks; but Siebel's were world-class, Fortune 500 companies that made enormous
commitments and served as a lighthouse for attracting others. In short, Siebel was in
a different class on Essential number three.

The fourth Essential involves leveraging Big Brother alliances. Tom Siebel knew
that his firm's growth rate was going to be constrained by attempts to do everything
internally, so he broke the mold. He removed that constraint by forming long-term
strategic partnerships with the leading systems integrators, such as Andersen
Consulting, IBM, Deloitte & Touche, and Cap Gemini. Those relationships became a
strategic advantage.

Onyx had its alliances, too, but they were smaller. Once again, Siebel commanded
best-in-class partners and scored high on this Essential.

Essential five, becoming a master of exponential returns, was critical in achieving

Siebel's $29 billion market cap in 2000. Onyx, by contrast, had only $407 million in
sales that year. Siebel outscored Onyx on gross margins, higher investment in R&D,
and on Sales and General Administration effectiveness.

Essential six, the management team, shows another distinct difference. Both had
inside-outside teams, but Tom Siebel and Patricia House could simply out-execute the
Onyx team across the three dimensions of Blueprint leadership: focus on product and
relationships, drive to explore and innovate, and the ability to simultaneously execute
all 7 Essentials. Onyx had good growth. Siebel had explosive growth.

18 AUDIO-TECH
On Essential seven, recruiting “Essentials experts” to the board of directors,
Onyx chose primarily venture capitalists and management team members. Siebel
stressed a team without investors. Charles Schwab bought 2.5 percent of Siebel and
joined the board. He had already built his own Blueprint Company. Likewise George
Shaheen of Andersen Consulting bought 10 percent and joined the board. Siebel scored
high on the Essential in structuring its board for exponential growth.

As the explosive growth of Siebel shows, the decisions made early in a company's life
can greatly determine whether or not a company reaches $1 billion in revenues.

■■

BLUEPRINT COMPANIES FOR THE NEXT DECADE

If America is to compete in the new global economy, it must foster the growth of new
Blueprint Companies, and at a much higher rate than in the past 25 years — a rate,
remember, that was only 5 percent.

All of the 7,454 companies that have gone public since 1980 began at the same place,
on an equal footing. The difference is that the Blueprint Companies shaped their big
ideas early, as entrepreneurs, into an economic framework that used the 7 Essentials
to deliver exponential growth. The success of these firms provides a proven pattern, a
blueprint, which can help other leaders to build new exponential growth companies
that can grow higher than you can imagine — all the way to $1 billion, and beyond!

■■

BUSINESS BOOK SUMMARIES 19

 ABOUT THE AUTHOR

David G. Thomson has been leading business growth for twenty years in general
management and executive sales/marketing at Nortel Networks and Hewlett-
Packard. He also served as an associate principal during his five years at McKinsey
& Company.

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