Egghead Inc.

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Egghead Inc.

P. O. Box 7004
22011 S.E. 51st Street
Issaquah, Washington 98027
U.S.A.
(206) 391-5160
Fax: (206) 391-0880

Public Company
Incorporated: 1988
Employees: 2,600
Sales: $664.8 million
Stock Exchanges: NASDAQ
SICs: 5734 Computer and Software Stores

Egghead Inc. is the largest retail vendor of personal computer software. The firm markets software programs to individual consumers as well as corporations, and offers detailed training in the use of its products.

Victor D. Alhadeff founded Egghead in 1984. Alhadeff had been involved in an oil and gas limited partnership until a drop in prices drove him out of business in 1983. Shopping for software later that year he found that salespeople at computer stores spoke in technical jargon that often confused the average customer. Alhadeff had sold shoes while in college, and with this retail experience, he decided that he could sell software far more effectively using traditional customer-friendly methods.

Using $50,000 of his own money along with $1 million from local investors—including Paul Allen, a co-founder of Microsoft Corp.—Alhadeff opened his first Egghead store in Bellevue, Washington. From the beginning, Egghead made an effort to make computer software less intimidating to the average consumer, projecting a warm image through the store mascot, a cartoon character named Professor Egghead. Salespeople received intensive training in order to become familiar with a wide range of software and explain it in simple terms. Egghead carried a wide range of software, as many as 1,300 titles, while its warehouse maintained a further 1,000. Customers were allowed to take software home for a 30-day trial period, and stores had up to four computers available for in-store demonstrations. Furthermore, Egghead featured extremely low prices, sometimes 40 percent off the list price.

With its unique approach to software retailing, Egghead’s sales rose quickly, and it soon was adding new stores. Corporate customers accounted for a major percentage of Egghead’s sales, and the company established a large direct-sales force in 1985. Soon it was selling to Fortune 500 companies like IBM and Boeing. Despite its growth, Egghead kept its costs down, investing its savings in new stores. The firm’s quick growth attracted attention and investor interest. Some investors were cautious, however, due to a controversy surrounding the bankruptcy of Alhadeff s previous company, against which several investors filed suit claiming Alhadeff had misled them about the company’s finances.

In 1987 Egghead prepared to go public. The offering was called off at the last minute, however, when the U.S. stock market fell dramatically in October of that year. Alhadeff instead raised $25 million in credit from the U.S. Bank of Washington, and several million more from private investors, including Prudential Venture Capital, for a total of $47 million in venture capital invested in Egghead. Egghead’s sales came to $77.5 million in 1987, nearly doubling sales of the previous year. Perhaps more importantly, the firm had profits of $2 million, after losing nearly $1 million in 1985 and 1986. However, in the rapidly changing computer industry, the firm faced new competitors. B. Dalton Books was expanding its Software Etc. division, which had over 100 boutiques, many of them in the bookstores, and Babbages Inc., carrying similar merchandise, doubled its stores in 1987 to 58.

By early 1988 Egghead operated 107 stores in 13 cities and maintained $40 million of software inventory. In June 1988 Egghead finally went public, with an initial offering of 3.6 million shares at prices above 50 times the firm’s 1987 earnings. Egghead used nearly $24 million raised in the offering to add about 100 new stores and put the rest into working capital. In one nine-month period, 64 new Egghead stores were opened as the chain tried to saturate the market before it was filled by competitors. As a result of this growth, Egghead stores and corporate sales staff accounted for about ten percent of U.S. software sales in 1988.

Despite annual sales climbing toward $350 million, however, profits declined due to the swiftness of expansion. In addition to opening the new stores, Egghead added 60 salespeople to the direct sales staff of 132. That meant an addition of 1,600 total employees in one year, and new salespeople required extensive training. As a result, the firm’s administrative and selling costs doubled in a year and its operating margins sunk from 4.5 percent in 1988 to about 3.7 percent in 1989. Egghead tried to obtain maximum profits from its low margins by getting volume discounts from software manufacturers. That meant increasing inventory, however, which was both expensive and risky in an increasingly unstable software market.

This tumult lead to two straight years of losses for Egghead, and the company was forced to close 29 stores to cut costs. With large volumes of software flowing quickly through its warehouses, control over Egghead’s inventory system slipped and theft increased. In 1989, in the midst of this period, Alhadeff hired Stuart Sloan and Matthew Griffin to help turn around the company. Sloan, who became chief executive officer, had a background on Wall Street, where he had led the leveraged buyout of Quality Food Centers Inc. in 1986. Griffin, who replaced Alhadeff as chairman, had made millions in real estate. The two put internal controls into effect that made each store manager responsible for the performance of his or her store. Retail store managers were sent monthly profit-and-loss statements for their stores, while district managers were sent statements for their areas. Furthermore, Sloan and Griffen refocused company efforts on selling software directly to corporate customers, who accounted for 60 percent of sales. The moves strengthened Egghead’s bottom line.

During this time, however, a new rival was emerging: chains of computer superstores that matched or beat the prices of Egghead’s software and also sold computer hardware. Egghead responded by strengthening its promotional machinery. When Microsoft’s MS-DOS 5 operating system came out, Egghead promoted it extensively, and sold it for $39.99, which was 60 percent lower than the $99.95 list price. Seeking to take advantage of its higher level of customer service, Egghead invested $3 million into training its sales experts. It also added 300 items to the store’s inventory, increasing the selection in the average store to 1,600 items.

By 1990 Egghead was profitable again, with sales of $519 million and profits of $15.4 million. However, a growing recession was affecting the sale of personal computers as well as PC software, and computer superstores were becoming more popular. Furthermore, hardware manufacturers were beginning to offer free software with hardware purchases, circumventing software retailers altogether. As software became more standardized and easier to use, Egghead’s customer service became a less significant advantage, and other retail outlets, such as bookstores and office supply stores, began to stock software. Attempting to boost sales, Egghead began promoting and licensing business applications by Computer Associates, the country’s second largest software firm. It signed a $3.5 million contract with SalePoint Systems to shift its point-of-sales (POS) software to IBM’s OS/2 operating system. The POS system linked the firm’s stores, distribution centers, and headquarters. Most software products were bar coded by version when the firm received them, helping its sales and distribution.

By the end of 1991 the firm had 205 stores in 20 states and sales of $665 million. It remained profitable, with earnings of $15.7 million. As Egghead continued to expand rapidly, opening 12 stores and closing two during the first quarter of 1992, earnings again declined. Furthermore, the company made a costly error when it overstocked Microsoft’s new Windows 3.1 software, predicting heavy demand that never appeared, in part because several computer manufacturers had already loaded the program onto their hardware as an added feature. Egghead fought back with an aggressive marketing campaign and planned to open between 20 and 40 stores by the summer of 1993.

Software industry price wars intensified during 1992, driving margins still lower, and Egghead brought in a new management team in early 1993. Timothy E. Turnpaugh, previously vice-chairman and operations manager at Seafirst Bank in Seattle, became president and chief executive. Griffin, who had resigned the year before, was replaced by Richard P. Cooley, a director and retired chairman at Seafirst.