What Happens When a High-End Product Becomes a Commodity

By Ryan Petersen, CEO, OCZ Technology Group, San Jose, Calif.
When I founded my company in 2002, we specialized in selling high-speed computer memory modules, also known as dynamic random access memory (DRAM), which is utilized in both high performance desktops and mobile platforms. We started out with little competition, but soon so many companies were making DRAM modules that they became a commodity, which drove our prices down. Even though our product was a high-end, we still had to set our prices within a reasonable range of what our competitors charged. By 2007, we had cut our prices from around $200 to $20 a module, and while our revenue was stable, the price cuts effectively wiped out our profit margins.

Drastic times called for drastic measures. We decided to completely shut down our DRAM business over the next few years, and start selling solid state drives (SSDs) -- a new, faster alternative to traditional hard drives. Although we saw huge potential in the SSD market, there was a small problem: It didn't yet exist. So, on top of having negative cash flow, we had to help establish the market we were about to enter.

Investing in our future
Though our profit margin was already low, we knew that if we wanted to make the transition successfully, we'd need to spend money.
There's some overlap between the SSD and DRAM technology, so we were able to retain most of our 325 employees. But to completely transition the company still required huge investments in research, development, employee training, and marketing. We held dozens of classes for our employees on understanding and selling SSD drives.

To keep up morale, we had to be liberal with bonuses. On a few occasions, as part of a plan to motivate the sales force, I went to the bank and withdrew thousands of dollars in cash. Then I went down to the sales floor and said for every $100,000 in SSD orders, the sales staff would each get a share of $1,000 in cash. If I ever had any question of whether people are motivated by money, now I know for sure: They are.

We also needed to educate our vendors about the new product. Some of our online retailers barely knew what SSDs were, and didn't have a proper category for them on their websites. We had to work with them to create new marketing materials, which cost us in terms of employee time.

To help manage cash flow, we asked third-party vendors to place orders for us. In exchange, we promised to pay them back later -- at even a higher rate. For example, we agreed to pay back one of our vendors in 45 days at an 8 percent increase. It was bad for our margins in the short term, but it allowed us to keep moving.

Even though our DRAM business was losing money and our SSD business wasn't off the ground yet, there were months in 2008 and 2009 where we spent $750,000 in working capital. It was scary, because we were counting on future returns on an investment -- but we didn't have a choice. If we wanted to make the switch, we'd have to spend the cash.

Sales first, investors later
We realized we'd eventually need additional capital to cover manufacturing costs for the SSDs. We waited until 2010, when we'd already generated a substantial backlog of sales orders.

We went to a few Wall Street hedge funds and pitched our company. It was a hard sell. Half of our company -- the DRAM half -- was limping along, and the other half was growing, but barely off the ground. To hedge our bets with investors, we had split our earning charts in the previous quarter to distinguish between the growing SSD part of our business and the failing DRAM parts of our business, and explained that we were just months away from shutting down our DRAM business. That helped ease their concerns, but the clincher was when investors saw our large backlog of orders. It was practically guaranteed income, as long as we got the capital needed to fill the orders. So far, we've raised $15.45 million.
Since we raised the funds to start filling our backorders, our revenue has grown exponentially. In month of August alone, we posted $11 million in sales, compared to $12 million for the previous quarter. From a broader perspective, the research firm IDC projects that the SSD market will grow from $1 billion this year to $5 billion next year, and to $11 billion in 2015. Going forward, it looks like we're in pretty good shape.

Ryan Petersen started OCZ from his garage in 2002, with $80,000 of his own money. Now, the company has $150 million in annual revenue and operates in five locations around the world.
-- As told to Harper Willis

Resources:

• Read veteran advice on how to manage your businesses' cash flow.
• Study tips on how to find investors for your business.