Question:
Given STM’s situation, what recommendations would you make for STM to exploit its current advantage? What do you recommend for Jerry Budinoff personally?
Case Study:
It was Mayof1990, and Jerry Budinoff-founder, president, and 80% owner of STM Technology, Inc.-sat in his office, looking at the large framed print on the wall. It showed a C-130 military transport plane, the kind Jerry had navigated for two years in Viet Nam. "That's what I want this company to be," he said. "A vehicle, capable of supporting large-scale projects in systems development. A rugged vehicle. The C-130 is exciting. to fly and tough to shoot down."
Jerry grinned as he contrasted that vision for the future with the short turn plans facing his nine-person firm. "First, we have to develop the expanded system features demanded: by our present customers. Then, I have to rewrite the Business Plan in order to attract $900,000 in new capital. Then
I'll switch back to my salesman role, to bring in the new business." He mused about the change in his thinking about the company's growth:
Originally, I thought if you developed good software and supported it well, you would be successful. That was all you had to worry about. That got us up to this point, but we really won't go any further until I worry about the business stuff.
We're at $3/4 million a year in revenue now; but-it isn't going to get any bigger without marketing, distribution, people, money-all of them. Just doing good software doesn't get it any bigger than this.
I just figured that out. It hit me like a club. It's that simple. We never had a business plan. We never had any long-range plan. The company just grew.
STM Technology, Inc., located near B05t0Iiin Acton, Massachusetts, was founded in 1983 to exploit Jerry Budinoffs skills in systems design and application. The first commercial customer was a small mental health center; STM had gone on to specialize in microcomputer-based management information systems for smaller health care providers and non-profit human service agencies. The product STM offered was more than just software. The company sold total systems: its Customer Support Department provided training, software support and consulting services, while its Hardware and Network Department provided hardware, multi-user local area networks and on-site maintenance services.
Since its founding, STM had installed some 129 systems in a wide variety of outpatient health care facilities. Revenues had grown steadily since 1983 and the company had been consistently profitable. By 1989 the company had developed a hospital management system based on personal computers-the first to run on PCs, according to Budinoff. This new product development prompted him to seek outside financing for STM, which had, until this point, financed its growth internally
Budinoff had concluded that proper exploitation of this new product and other systems required financial backing.
The microcomputer software industry
In the early 1980s, following the introduction of IBM's personal computer and wide market acceptance of microcomputers, demand for application software skyrocketed. Hundreds-then thousands-of individual entrepreneurs founded businesses as designers, programmers, distributors or retailers of computer software. By 1988 there were approximately 30,000 microcomputer software manufacturers in the U.S., producing more than 70,000 products, according to the CIRR Index, 1989. In the Boston area alone, the "Business to Business" telephone directory listed 906computer software and service firms, and 555 computer systems designers and consultants.
This proliferation of entrants in the industry required firms to do more than just produce technologically sound products, if they wished to grow. By 1990, success in the industry called for brand development and firm name recognition, marketing and support, and product development and enhancement; Business expertise in marketing, sales, and support became increasingly significant as prerequisites for success. Jerry Budinoff commented on the importance of providing service:
Hardware and software require a lot of support. Technology changes quickly, and if you're not supporting the changes they just run by you. We're small, but we try to provide all of the services. That's what really sells our products. It's not just the system; it's all of the training and support. A system is not just software. It's the whole human element and you have to concentrate on the people side with your service.
THE HEALTH CARE INDUSTRY
For several decades, expenditures on health care had represented the fastest growing sector of the American economy. The adoption of government payment programs (Medicare and Medicaid) in the mid-1960s and growth in private insurance (such as Blue Cross/Blue Shield) encouraged the use of health care, since most people could pass their medical costs on to third party payers. Estimated total U.S. health care expenditures for 1990 were 2.6 times the level of 1980, at$647 billion.
As medical costs rose, governments and employers who were paying the bills came under increasing budget _pressure. Repeated efforts to control costs showed little effect. In October, 1983, the federal government changed its Medicare payment policy from full reimbursement for hospital charges, to reimbursement at predetermined rates for specific treatments. The government set rates for hospital services according to "diagnostic related groups" (DRGs), resulting in standard reimbursements for medical treatment, regardless of how long the patient remained in the hospital. This new fixed-fee payment system provided strong incentives for health care facilities to control costs, since payment rates were non-negotiable. Hospitals immediately began to send patients home to complete their recuperation.
Employers also responded to the ever-rising costs of employee health benefits. Some companies raised their employees' portion of health insurance premiums; some increased efforts to promote overall healthy living; still others encouraged employees to elect lower-cost plans like health maintenance organizations (HMOs).
These changes in health care payments did not, however, curtail national health care spending. Health care's portion of the gross national product grew steadily from 5.2% in 1960 to 11.5% in 1988. The increase, due partly to the aging population and partly to costly advances in medical technology was expected to continue. In 1989, the S&P Industry Surveys, "Health Care," showed that 11% of the total national population was over 65 years of age and generated 35% of the country's total health care bill. Older patients required more attention, thus increasing the labor costs of most health care facilities. Additionally, the number of diagnostic tests, medical treatments and prescribed pharmaceuticals billed, by hospitals to their patients increased greatly, even as hospital stays dropped under the pressure of the DRG payment system.
Except for outpatient services, hospital utilization declined steadily after 1983. Hospitals faced tighter margins, due to lower admissions and inadequate reimbursement. DRG rate increases lagged behind actual cost increases for health services, and under the Bush administration this condition was expected to continue: Medicare's fiscal 1990budget was cut by more than $2 billion. Additionally, hospitals had to contend with the high cost of preventing in-hospital contraction of infectious diseases such as AIDS along with increasing liability insurance.
Declining usage and tightening margins hit small public and rural hospitals (those having fewer than 100 beds) especially hard. Many public and rural hospitals faced the threat of bankruptcy or closure. In addition to inadequate DRG rates, these hospitals were adversely affected by demographic changes and the distribution of federal health care funds. Increasing numbers of young rural residents moved away, reducing the tax base which supported community health care and shifting the balance of patients to an older, more Medicare-dependent base. Rural hospitals generally received 40% less in Medicare reimbursement per case than did urban hospitals, because government audits showed that rural hospitals had lower operating costs. A study by the University of Illinois Center for Health Services Research, quoted by S&P, found that 161 rural hospitals closed between 1980 and 1987, with 70% of those remaining losing money in 1987.
And 600 more rural hospitals were expected to close before 1990.
Many hospitals attempted to compensate for declining revenues by shifting the weight of costs to private patients. Private and corporate consumers, however, reacted by seeking alternate means of health care. Outpatient services grew substantially in usage. In 198018% of all surgical procedures were performed on an outpatient or ambulatory basis. This increased to 28% in 1985 and was expected to be at 59% by 1990, according to Joyce Keithly, writing in Nursing Economics in 1989.
Health maintenance organizations first became a key component of health care in 1973with a law requiring many corporations to include HMO coverage in their health care benefit menus. HMOs operate on fixed cost contracts with health care providers, eliminating any fee for service. Although there was some concern that HMO's protection might be discontinued, a Duff & Phelps HMO industry analysis expected annual membership growth to continue (see Exhibit 5) and revenue growth to remain near 20%.
In summary, health care providers felt intense pressure in 1990 to
EXHIBIT 5
Growth of HMOs-1980 to 1988
Prepaid Enrollment
Date plans. (Millions) 0/0 Population
June 1980 236 9.1 •4.0%
June 1981 243 10.2 4.4%
June 1982 265 10.8 4.7%
June: 1983 280 1.2.5 5.3%
June 1984 306 15.1 6.4%
December 1984 337 16.7 7.1%
December 1985 480 21.0 8.8%
December 1986 593 25.0 10.40/.,
December 1987 650 30.0 12:2%
June 1988 643 NA NA
control costs. A prime area for their attention was administrative systems, where hospitals had automated many of their processes but smaller institutions had been unable to afford the high costs of modernizing systems to improve' their efficiency.
STM'S COMPETITIVE SITUATION
A number of large competitors and a multitude of small ones served the medical market with computer systems, said Budinoff:
Meditech; IOX, and Baxter are big in the hospital systems market, for example, but they don't bother with outpatient clinics. Baxter is huge. But their product sells for
$250 to $300,000to get the whole system in, including hardware. Baxter 'and IOX will both lease their systems at $75,000 per year. Clinics can't even look at that kind of money and even a hospital of 100 to 125 beds can't afford it: They may pay it, but they're real unhappy.
Baxter International, a major supplier to large hospitals, was a manufacturer and distributor of health care products whose 1988 sales reached $6.8 billion. Baxter's products included intravenous solutions, dialysis and blood collection equipment, drugs, urological and diagnostic products, cardiovascular devices and information systems. Additionally, Baxter operated 120 of its own outpatient health care facilities.
The big guys have had their systems out there for several years, and they're all based on minicomputers. We want to go in with a PC-based system that sells in the Neighborhood of $75 to $90,000.We're the first ones to .do it on PCs, and we have to get the financing so we can develop it properly and grow it before the others copy us..
It's not easy to downsize a system from minis to micros, and the big guys have a minicomputer mindset. We have maybe a year's lead,
STM did not offer a lease plan to its customers. "I have no training in business," said Jerry, "and that kind of arrangement requires a lot of expertise.”
Small hospitals and clinics, Jerry said, were "an everywhere market."
Some 60% of hospitals tabulated in the 1989 American Hospital Association's data were below' 200 beds in size (see Exhibit 6), and there was evidence that the smaller hospitals were having difficulty finding the systems they wanted. A survey of 3, OOO hospitals with more than 100 beds, conducted by Modern Healthcare (see Exhibit 7), indicated a large number of small shoppers for systems, with many purchase plans cancelled or delayed for years.
The small institutions were served by a few small companies-Practices Management Systems, at about $5 million annual sales, was the largest-and by a legion of independent operators. Many of these, Jerry thought, were amateurs or programmers who had built a system for their own employers and were trying to peddle it to others. As "basement operators," they often quoted unrealistically low prices. Wise buyers in the market had come to demand evidence of a supplier's financial stability.
Every successful installation, Budinoff felt, would generate new sales through word-of-mouth contact from satisfied customers. Already, STM's development work in five hospitals was generating inquiries beyond the firm's capacity to service them. Jerry had just decided against pursuing a California hospital inquiry; the distance made installation and support unfeasible. Still, many hospital and clinic administrators desperately wanted economical systems.Budinoff had first hand knowledge of their problem:
I've had directors of facilities get a little annoyed with me because they wanted something like our system but didn't know we existed, so they bought something else. When they found out about us they'd call and say "Where the hell were you when I needed you?"
• STM TECHNOLOGY, INC.: CURRENT PRODUCTS
The success to date of STM was attributed to the sales of its Outpatient Billing and Administration System; with an installed base of 129 systems in the fall of 1989.Jerry estimated the market to be approximately 2,500 clinics in New England; he was targeting an additional 335 installations over the next four years. This estimate was based on a significant upgrade to the present system, automating nearly the entire billing process. The new STM "Robotic" version would incorporate automatic scanning of services at the front end and electronic transmission and posting of receipts at the back end. Little or no hand data entry would be required. This new version could be marketable in four months with additional R&D funding, Jerry said.
Two additional products had been developed: a microcomputer In-patient Billing and Administrative system targeted at small hospitals (under 150 beds), clinics and HMOs; and a Patient Database which provided a Medical Tracking and Analysis system linked with either the Hospital or the Clinic systems. These programs formed an interrelated family of products which met the need for affordable, integrated medical systems. STM continued its market research in order to add to this 'family of products further through the development of new and follow-up software.
The Medical Tracking and Analysis System was a system to track the health care data of patients 'throughout their lifetimes. It could be integrated into the Billing and Accounting System, but could also be available as a stand-alone product .The product needed six to nine months to complete, after funding came in. Jerry viewed the market as nationwide and potentially worldwide. He had targeted 245 sales within four years to employee assistance program providers, employers, government agencies and health care practices.
~ STM TECHNOLOGY. INC.: HISTORY
Jerry Budinoff was an electrical and astronautical engineer by training. He began working with computer systems shortly after leaving active duty with the Air Force, and joined Proctor and Gamble as a production manager. While working with computer professionals there, Budinoff discovered that he really enjoyed systems design. This would be his new profession.
After P&G, Budinoff worked for DEC and Raytheon, to gain management experience.
Budinoff says, "I had a friend who thought you couldn't really run your own company unless you could be an executive in a large corporation. So I got to where I worked for a vice president. Then I said, 'Okay, I can do this,' and started this company."
In 1982, Budinoff left Raytheon to develop systems and start STM. He describes his entry into the Health Care market:
It was an accident .The first person I found who wanted a system developed happened to own a mental health center. That was it. There was no formal market research. It could have been a gas station. It didn't make a difference to me. I was a techie and I just wanted to develop software,
After Budinoff incorporated the Company in 1983 he brought t in Evelyn Mittler (a Raytheon programming consultant) as a 10% stockholder, and Richard Kelley (a software development administrator from Honeywell). It was with this limited staff that STM developed software products to enter the Health Care market, focusing on systems for non-physician outpatient facilities.
Budinoff saw STM's ability to serve a wide variety of outpatient clinics as his competitive advantage. He commented on this and the derivation of the company's name:
Mental health facilities, rehabilitation facilities, substance abuse facilities ... there are no other general-purpose systems out there that are right for all of them. Maybe 50 to 60 percent of them are non-profit; and. systems for them are much more difficult to do than for physicians. So there is much less competition for systems work for these facilities: everyone sees physicians as the big market, and these other things are much smaller.
There is no one who competes in all the different kinds of places we're in. We run into one set of competitors in mental health facilities, and another set in substance abuse companies. We're the only one with a .generic product-one that serves all kinds of clinics. That is an advantage because when one of these guys gets aggressive and starts doing very well in some market, we can •turn to another market. We're always going one direction or another within health care, while our competition is tied to one market and they go up and down as that market moves.
One thing all our customers have in common: they all want to save time and money.
That's what STM stands for- "Save Time and Money." When I first went out to the market, I asked what people wanted. They said, "anything that saves me, time and money," so I put that right into the name. A panel at Harvard said it was a "harsh and non-descriptive" name for a company, where you want a name that's Warm and friendly. But I want to ten you our customers and prospects remember it and identity with it. It always gets a smile. They greet me, "here's the guy who’ll save us time and money." Maybe that's why I haven't gone to Harvard.
In its first six years of operation; STM did not have an office facility; all employees operated out of their homes. In July, 1989, Jerry leased a 1,400 square foot, ranch-style building. A classroom for weekly training sessions and tastefully-decorated offices for all the staff occupied the first floor. An equal-size basement, vacant but subject to rental, would provide expansion space when funding permitted the increased staff. STM at the time employed nine people who provided administration, hardware maintenance, customer support; training and programming. Budinoff did most of the systems design work and was also the company's only salesperson. Evelyn Mittler, whose 24 years of systems and programming experience included extensive service With Raytheon, Varian and Wang, assisted with design and was in charge of coding. All STM programs were written in COBOL. "It may not be the newest language, but it is much easier to find customer support people who understand COBOL," Mittler said.
STM had no affiliation or official status with the computer manufacturers whose hardware they selected for customer systems. Some years earlier, an IBM Value Added Reseller had offered Jerry a System 36 minicomputer, hoping he would program the Outpatient Management System for their machine. "Even then, we thought the minis were dinosaurs, so we didn't do it," Jerry said. IBM itself was now showing interest-this time with the thought of selling STM's software along with their PCS and the new "6000 series" machines. Budinoff' was hesitant, however; "I don't understand that kind of inter-company dealing," he said, "and it would take an immense amount of time to learn it."
As it became apparent during 1989 that the year would be profitable – so profitable that substantial taxes would be due-Jerry Budinoff decided to invest in additional marketing. He employed a salesperson for six months.
Budinoff described him as "not having an in-depth knowledge of the product and the market. He tried to sell on personality and didn't get anywhere. This isn't like selling a car. And he didn't want to get the knowledge. We parted company," In 1990STM's marketing still relied only on Budinoff's efforts, word-of-mouth between Health Care organizations, a couple of ads in the yellow pages, and past attendance at a few trade shows.
~ TH E STM BUS INESS PLAN
In January of 1990, in order to solicit investments from venture capitalists, Jerry developed a business plan which aimed to take advantage of STM's innovative PC-based systems for small hospitals. The plan sought $900,000in new capital (two-thirds in debt, one-third in equity), which would support the hiring of a director of operations, who will relieve Mr. Budinoff's time for concentration on the key skill of systems design . . . immediate expansion of the programming and system analyst staff;. . a director of sales and marketing." who will hire the telemarketing and sales support staff . . . and a Chief Financial Officer. ...
The new funds would be used, the plan said, in approximately- the following amounts:
Research and Development $350,000
Extra Marketing Expenses in 1990 440,000
Hiring of new professional staffs 110,000
STM's business plan projected growth to 74 employees by the end of 1993, with sales just over $10 million (see Exhibits 9-11). Jerry Budinoff commented on the opportunity:
I never wanted to get financing before. I never understood the business side, or the huge need for capital. But we've been in the health care market for six years now, and I do know what that market needs and how to design for it. We've got a real lock on it. I am positive that if we get the financing this thing is going to go through the roof like a rocket ship. There is just no doubt in my mind. So I'm not worried about the financing it will be paid back. We just need the $900,000; that's the difference between total expenses and total income in the first year of the plan.
But we have to take the new inpatient hospital system into the market the right way, not just dribble it in. Because as soon as we get visibility and prove to the market that 386s and 286s can do the job, then one of the big companies will come in. When we break the idea barrier, they'll get going with their resources, and go right by us with marketing. We have maybe a year's lead, but if we don't get going we'll lose our real window.
Of the five hospitals with installed systems in 1990, two were in Massachusetts; one each were in Connecticut (at Yale University's infirmary), New Hampshire and Maine. The business plan estimated the market as 3,000 small hospitals nationwide and 450 in New England. It targeted 235 installations in the next four years, representing a 12% market share nationwide.
The plan envisioned growth in STM's outpatient systems as well, based on selling the new "Robotic" integrated system to clinics throughout New England. Nineteen new sales in 1990 to Massachusetts facilities would bring that state's total to 143, representing 13% of its potential market. Twenty-six new sales were targeted for the six other New England states. For the first time in its .history, a marketing campaign of mailings, trade journal advertising and telemarketing would supplement the word-of-mouth networking which had so far carried STM.
The proposed marketing program began with direct sales by STM's own staff, expanding to branch offices in New York City and Tampa in 1991.
California, Texas, Chicago; Denver, and St. Louis would follow in 1992.
These remote sites would cultivate local vendors to provide hardware and maintenance, and eventually distribution of STM software. New products-including some for diagnostics - would be sold through mail order arid off-the-shelf through computer stores. By 1993, the plan called for marketing outside the continental United States. To support these efforts, a variety of new promotional tools had to be developed, including new product packaging, advertisements, news releases, brochures, an exhibit booth for trade shows, a sales kit, sales training materials, professional videotapes and telemarketing scripts. The business plan put the cost of these marketing and sales tools at $260,000. .
To Jerry, the new financing was absolutely critical. Without it, he saw little point in continuing development work on the hospital system at all In May of 1990 no new sales of the existing inpatient system were contemplated. The development work had to come first, Jerry commented;
I deeply believe in the philosophy I learned at DEC: don't try to force a product onto an unwilling market-let the market pull you in, Well, we were pulled into the hospital market, without knowing better It is a very difficult system, and we might not have done it if we'd analyzed it first We successfully automated what the hospitals were doing already. In the process, we have learned what the market really wants, and that would be a product that opens up the entire market.
But we ought to do it right. Without financial backing, we can't even begin to cope with that market We would just make a little dent in it I know how to "piecemeal" into these markets, and that's exactly what I don't want to do.
Budinoff and STM's two other equity holders were willing to relinquish 33% of the ownership for the $900,000 they sough t. STM had already refused a $500,000 offer from one of its customers, for 48% of the company.
Health care is a very parochial, localized market. And we've got an image problem because we're the little guy in the market and people worry about us going out of business. My criterion for capital is credibility. I want someone who can give us credibility and who can give us second and third rounds. Ideally I would like a large computer-based company such as an insurance company to back us. That way they would have an interest in us. They could turn to us for consulting help. I'd be more comfortable with that.
I suppose one of our options, though, if the financing didn't come through, would be to shift into "retirement mode -stay small, and make a pile of money.
Evelyn Mittler, who had been quiet through much of the conversation, winced at this last suggestion. "Oh, no," she said. Jerry continued:
Yeah, we could stay at about $750,000 a year, with a gross profit of maybe $300K.
There are lots of other people who need systems work done, outside of the business.
It's a never-ending market. I get calls all the time; it's hilarious. I was down in Washington [jerry served one week per month as Reserve Assistant Division Chief for the Air Force Arms Control and International Negotiations Division, designing computer systems to comply with the Strategic Arms Reduction Treaty J, and they wanted to know how to automate a whole Pentagon division of operations. I'm no expert in that, but it doesn't matter to them. I've got the reputation, and that's it. So we could turn away from growth in the medical systems.
"But none of us wants to," said Evelyn Mittler.
"We could cut back on the R&D, and reap profits for the business," said Jerry. "But we're not interested in just going along at a steady size."
"That would be boring." said Evelyn Mittler.
Jerry Budinoff concluded:
I view the Company as a vehicle - a resource base for the fabulous systems we'll develop next year and the year after that. That's what my core group of people like doing and we're very good at that. Now I have to get the Company big enough to support what we come up with. I want to move it out of Health Care and into other markets too, eventually. In six years I would like us to be a $20-30 million company.