Supply chain management is hot. Investment is flowing into supply chain companies. In 2021, more than $25 billion was invested in supply chain companies in just the first three quarters of the year.
One successful private equity backed company is the unicorn Locus Robotics. Bruce Welty was one of the founders. Mr. Welty understands both private equity and supply chain management. He has the battle scars to prove it.
Fail Until You Win
Mr. Welty founded a company that sold warehouse management systems (WMS) called AllPoints Systems in 1987. Mr. Welty tried to accelerate the growth of this WMS company with outside investment. But, despite repeated efforts, he was never able to attract outside funding. He sold the company in 2001 when the company had achieved revenues of about $10 million. It was not a successful sale. The company buying his company, EXE Technologies, is now infamous among those who have followed the WMS market. EXE Technologies bought AllPoints with stock. EXE’s stock proceeded to tank; Mr. Welty was left with little to compensate him for 13 years of effort except for hard won experience.
He went onto become an executive-in-residence at Great Hill Partners in the early 2000s. At the time, Great Hill Partners managed 2 investment funds with over $300 million in equity capital (today Great Hill manages closer to $6 billion). Executives-in-residence are looking to join the executive team of the target company but also may be considered, in a sense, an insurance policy. If the private equity group feels the existing CEO is not working out, an executive in residence can be inserted into the company as the new CEO. Executives-in-residence are also industry experts that understand the nuances of an industry better than the equity firm’s financially-oriented partners and can thus help the partners better understand whether a potential deal should or should not be done.
Following this, Mr. Welty purchased a WMS company which became the platform upon which he created a different business called Quiet Logistics, a third-party logistics company focused on picking ecommerce orders with robotic technology. This was a unique and, for those that understood ecommerce fulfillment, an exciting business model. After a few years of working on the business plan, Mr. Welty approached his former colleagues at Great Hill Partners and they made an investment. “The first investment was minimal – in the hundreds of thousands of dollars. It was really intended to allow us to buy a few robots and rent some space, just get us started” and prove the business model.
Within 6 months, Quiet Logistics had customers. “We went back to them, and we asked for a lot more money. We asked for $2 million to buy more robots and then shortly thereafter another $4m. We had the demand. We just needed the robots to satisfy the demand. They totally got that.”
Ultimately, Mr. Welty and his team raised $9.5 million to support the Quiet Logistics business model. By 2012 Quiet had revenues of $37 million, was profitable, and in no need of any more investment. “If somebody was going to invest in us, I think they would have fairly given us about a valuation in the range of $50-$75 million.”
Then the bottom fell out. Quiet Logistics had been buying autonomous mobile robots from Kiva Systems. Kiva had pioneered a new class of robots – autonomous mobile robots – that were much easier to install, scaled easily to meet growing demand, and had a lower risk profile than bolted down forms of automation.
Unfortunately, Kiva Systems was bought by Amazon. Amazon paid $785 million, a price that at the time seemed outrageous but has since proven to be an excellent investment.
Amazon initially told Kiva’s customers they would continue to supply and service the robots that Kiva had sold. Then over a year later Amazon changed their mind. “Amazon called us up and said we are discontinuing our support for the commercial business. Basically, they were saying you can’t use these robots anymore. At that moment our valuation went to zero. You can’t sell the business. Nobody wants to own that problem.”
“So, we had a company that lost a lot of value that day. After a 3-month search for alternatives, I went to my investors and I said, hey guys, we want to build a new robot. Their attitude was, ‘You know, Bruce, you had something that was worth something yesterday and today its worth nothing. And now you want us to give you $2 million more?’”
“My answer was, ‘Well, yeah, if we don’t put in $2 million more than we all walk away with nothing. If you put in $2 million, we have a chance to salvage something.’” In the investment world that could be called throwing good money after bad. But Mr. Welty had successfully built two companies, had a background in warehouse technology, and had earned some trust.
That was the genesis of Locus Robotics – a company that makes its own version of autonomous mobile robots. Locus was separated out of Quiet in 2016 and became its own company. Quiet was able to buy Locus robots and continue operating as an efullfiment service provider that relies on robots. At that point, it was possible to raise money into both Locus and Quiet as pureplay entities. Quiet was sold in late 2018 to a new ownership group and then sold again by that ownership group in late 2021 to American Eagle Outfitters for $350 million.
Locus, in turn, generates over $100 million in annual revenue, has seen its customers complete their 1 billionth pick, and has deployed over 10,000 robots. The Locus team achieved that in just a few years. The company has raised $300 million in capital and is valued at over $1 billion.
There is No X Factor
Mr. Welty says there is no one thing that makes a firm attractive to outside investors. But there are 10 things that can be done to build the “perfect business that investors can’t say ‘NO’ to.”
First, private investors want to see a large and growing market. “In our field, supply chain management, there is a huge market. You don’t really have a hard time proving that you have a big market. But you do have to prove that you can sell your product across a pretty big sector of that market. Your market within a market must be big.”
Secondly, private investors also like to see “unfair advantages.” “For us, Locus has an unfair competitive advantage. This was because we were the only people at the time really to have a product – remember Amazon had ceased sales of Kiva. We had five years’ experience with Kiva and were one of very few companies with this experience. We understand how warehouses worked and how this product was going to fit into that environment. Locus is a complete solution that solves the problem quite elegantly.”
Locus has a strong patent portfolio but generally patents provide only limited protection. Other companies can read the patent and may be able to reverse engineer the product in a way that does not infringe on the original patent. But even if they do infringe on the patent, proving that is a “litigation nightmare.” In the final analysis, in the two or three years a rival takes to bring a me-too product to market, if your company continues to innovate, “you will retain that unfair advantage.”
In short, Locus’s experience with the technology combined with their industry domain expertise made for a unique product. “It’s very, very hard to create unique product,” Mr. Welty exclaimed.
Thirdly, investors also like a company that cannot be disintermediated. A company is part of a larger ecosystem. It should not be possible to another company in that ecosystem to step in and eliminate a fast-growing young company. In a way, Quiet Logistics was disintermediated when Amazon bought their supplier Kiva as part of Amazon’s own vertical integration strategy and as a way to improve their own advantages. Amazon has exploited this advantage and has deployed over 500,000 Kiva robots across its own network.
Fourth, private investors love an annuity revenue model. “The idea here is that you sell a thing once, but you get paid forever.”
Fifth, outside investors also like “transaction-based pricing – this is where your revenue grows as your customers’ use of your products grows.” In the case of Locus Robotics, more picks require more robots which results in more revenue. The more picks the robots make, the more money Locus Robotics makes.
Sixth, “the product or service you sell must be a ‘need.’ It can’t be a ‘want.’ People give up on their wants before they give up on their needs.”
Next, “the product or service can’t be ‘offshoreable.’” It is impossible to compete with low-cost labor so there must be something about your product that makes it impossible to send overseas. It must be complex, or have a low labor component, or needs to be built or provided locally (fulfillment for instance cannot be provided remotely). In the case of Locus, the labor to build one of the robots is quite minimal, so the labor savings would not be offset by the high shipping costs.
Eighth, the products should be capable of revenue growth in multiple dimensions. In the case of Locus, Locus makes more money from more transactions. But they also sell multiple types of robots and can sell them across multiple warehouse sites.
In short, when you get a new customer, you want to be able “to expand that relationship with that customer in multiple directions. You also want to add more customers. That’s multidimensional growth!” Being able to sell in multiple dimensions to existing customers while also selling to new customers lowers a company’s cost of sales.
Ninth, a low customer acquisition cost is attractive. In logistics, it used to be that selling a WMS could take a year or more because the customer would need to spend a million dollars or more on the software and implementation. That kind of investment warrants some time. But with Locus Robotics, customers can start with just a few robots at one site, prove it out, and then invest more. Plus, the robots are sold “as a service” and provided under a subscription model so no capital expenditure (CapEx) is required. That makes for shorter sales cycles because the customer sees an immediate return and does not need to make a capital request.
“You want to be sure that you know you’re not spending more money to acquire the customer than you’re ever going to make in profit on that customer. Margins matter – “what that means is that you can sell a product for a lot more than it costs you to make it and sell it. “Microsoft’s margins are in the 30s. Some drug companies are in the 90% range. But I mean, if you make $9 in profit for every $10 of revenue, your customers are valuing your business quite highly.
Mr. Welty is puzzled by the investments in companies that provide home delivery of groceries, microfulfillment and ride sharing services. “Their metrics just don’t make sense. These are negative gross margin companies. If you add the selling costs to the cost to make a product, they are actually paying their customers to use their products. That is a charity, not a business!”
Finally, fragmented markets can be attractive. Industries are fragmented, or have many players all with small market shares, in the early days of the industry. If the industry has matured and is populated by a few large competitors “a lot of the opportunity has been taken out by the big guys that have already succeeded.”
Successful serial entrepreneurs are a rare commodity. I suspect we have not seen the last of Mr. Welty.
Leave a Reply