Growth Strategies for Machine Vision Companies

As any economist will tell you, demand breeds manufacturing efficiency and technological advances, which lower prices and spur additional demand. Increases in volume are supposed to make up the reduction in per unit costs to the general betterment of the market and to the detriment of weaker players. Consider the machine vision (MV) lighting market where the emergence of LEDs has led to a new way to illuminate vision applications. This led to a significant reduction in per unit costs (especially life-cycle costs), higher volumes, and heightened merger and acquisition activity.

Ultimately, the question becomes ‘how does a vision company stay healthy in today’s market and weather the winds of change, whether it’s a new technology or new market direction?’ The answers, according to our experts from Wall Street to the boardrooms of major corporations, are many and involve all parts of the enterprise, including business organization, product mix, mergers and partnerships, access to funding, emerging markets and more.

Machine Vision: Who We Are
While every vision company is different, there are common threads among most. A majority of the hundreds of vendors and even more integrators that make up the vision industry were founded by an individual or small group of individuals, have less than a few hundred employees, and generate less than $50 million in revenue per year. Only 28 of these companies that make more than 50% of their revenues from vision products and services are publicly owned. The large majority of these companies have been in business for several years, some going back as far as the 1970s, and in many cases, the founders are in their 50s, which means that within 10 years they will have to decide what’s next – for themselves as well as their businesses.

Moving past the demographics, machine vision companies also tend to be specialists. Specialization can lead to fragmentation where small companies develop deep understanding for a particular industry. This specialization yields robust solutions for customers based on in-depth knowledge of their industry and requirements, but it can pose challenges for the vendor as underlying market conditions change and new products or directions are needed. According to AIA director of market analysis Paul Kellett, fragmented markets also tend to lack large corporations with the power to set minimum prices and drive an industry, which can lead to price competition and market instability, which in turn leads to consolidation and, eventually, the return of market stability. Finally, as the market continues to grow, large corporations from related industries (think digital imaging/lighting/sensors/etc.) may be inspired to move into machine vision, which can spell trouble for the existing players if they’re not prepared to respond. Both smart cameras and LEDs are examples of successful technologies that have recently attracted attention from corporations whose core business is outside of machine vision.

While this may all sound gloomy for the vision market, the truth is just the opposite. The vision market is healthy with key product categories growing at up to 29% in recent years and future annual growth projections as high as 15%. Flux is, after all, the one constant in market-based economies, and like most market challenges, hidden inside is an opportunity.

‘‘What do you do in a tough market?’‘ asks Peter A. Hunter, a general partner with Axia Capital Partners, L.P., a private equity firm that specializes in small- to mid-size industrial automation companies. ‘‘That’s the time to get more aggressive, not less. The challenge of small to mid-sized companies is that they tend to not have enough resources or the ability to become aggressive. So they adopt a ‘‘hunker down’‘ approach, while larger companies take market share.’‘

Three Common Problems
Axia’s Hunter identifies three problem areas for small to medium technology companies: limited product breadth, limited markets, and limited human and financial resources.

‘‘Many MV companies are in niche markets such as imaging hardware, software, etc., for a specific industry such as food, or semiconductors,’‘ Hunter explains. ‘‘They’re locked into where their markets go and, in many cases, their success is often determined by whether the markets they sell into are early adopters of technology or not. Limited financial and human resources are also a problem. Many founders/entrepreneurs don’t know how to take a company past $5 or $10 million in revenue. It’s not an easy thing to wear eight hats, manage a lot of people, product portfolio, and customers. Many machine vision entrepreneurs have trouble with that.’‘

More Products, Please
The questions of pursuing new markets for existing products or developing new products for existing markets are closely related. Pointing to the recent acquisition of backend semiconductor process tool maker August Technology by front-end semiconductor tool maker Rudolph Technologies and a half dozen other recent deals, president of Vision Systems International (VSI), Nello Zuech says, ‘‘The whole idea is to give your salesmen more products that they can turn around and sell through the same distribution channels to the same customers.’‘

Expanding a company’s vision portfolio within a market niche is part of what propelled Cognex to the position it has today, according to senior vice-president and group business manager, Justin Testa. ‘‘We started out by supplying wafer tracking technology, and over the next fifteen years we continued to innovate and design machine vision tools to meet [the semiconductor industry’s] need for inspection, metrology, and robot guidance. As [the semiconductor industry] grew, so did Cognex.’‘

Adding vision products within an industrial niche is one way to grow the product base, but a second way is to add non-vision products to your sales and distribution line to further serve an application-specific customer.

‘‘One of the most interesting talks I ever heard was Ken Levy talking at an AIA Business Conference when he described KLA Tencor as a yield management company and not a vision company, even though a majority of their revenues come from vision-type products,’‘ says VSI’s Zuech. ‘‘He said there are specific process steps in the semiconductor industry and we’re going to go out and buy those companies that offer solutions to provide yield management tools regardless of technology. Heck, every segment of manufacturing has smart sensors and diagnostic tools that should all be in the same catalog.’‘

Many small companies do not have the financial resources to ‘‘go out and buy’‘ companies that offer complementary process solutions. Licensing and partnerships can be a faster path to product breadth and depth.

‘‘All things being equal, it’s easier to add products to a market and customer base that you know rather than break into totally new markets, particularly if you have good success with your customers,’‘ explains Axia’s Hunter. ‘‘There are a number of ways to enhance a product line, including internal development and acquisition.  For small companies with limited resources, however, a lower cost alternative path is a partnership, joint venture or licensing arrangement. You find a product or technology that you think your existing customers will like that’s perhaps in another vertical market and you license it to sell to your markets. Typically, a license arrangement is royalty-based with little up front consideration. In other words, it’s ‘success based’. You have to walk before you run. For small companies, the lowest cost alternative to acquiring products is generally through licensing, then joint ventures or partnerships, then internal product development, and lastly, mergers and acquisitions of products and/or companies.’‘

Critical to this success is deep understanding of a target market’s entire manufacturing process. ‘‘Application knowledge is important,’‘ adds Cognex’s Testa. ‘‘Cognex has always worked hard to understand the business and operational challenges of our customers, so that we can develop machine vision features and tools that these customers want, and are willing to pay for.’‘

Emerging Markets
Another way to maximize return on a product portfolio is to find new regions within the same industrial segment. China and India are the most cited examples of booming markets in emerging countries, however, Rick Eastman, manufacturing analyst with investment firm Robert W. Baird & Co., Inc. cautions against thinking the road to the Far East is easy.

‘‘In the industrial automation space, access to foreign markets, the cost of reliability and sales capabilities are high,’‘ Eastman says. ‘‘Global markets aren’t structured in ways that smaller companies in the U.S. are used to. You can’t always link to existing distribution systems. The costs of going to direct sales in China, for instance, are extremely high, but they are a requirement if you want to be successful. Companies can be better off connecting with an organization that is already established in the host region.’‘

Again, partnering rears its head as an important growth strategy, not just for product breadth, but to fill regional needs and support. ‘‘There’s another difference between North American and European markets and emerging markets. The U.S. and Europe traditionally accepted a component approach relying on an established infrastructure of small, local engineering firms to add their value to build out a shop floor. Emerging markets want a solutions approach, as the local engineering support structure is not established,’‘ Eastman explains. ‘‘They want drop-in plant automation and seem less tolerant to look at components and build up a shop floor. They want a proven solution, with service from one vendor, and are not willing to cobble together a solution over time.’‘

In other words, if you don’t have all the automation components a client needs, consider partnering with companies that help you fill out the solution and already have access to key regions.

Human, Financial Resources
While the cost of expanding sales into new regions can be high depending on the local infrastructure, culture, and national distribution schemes, sales and marketing can also be problems in a small to mid-sized company’s primary market.

‘‘In our experience, many entrepreneurs do not invest nor have the patience for sales and marketing.  Alternatively, they prefer to wait for orders to come to them, and the good companies do reasonably well doing that,’‘ notes Axia’s Hunter. ‘‘But outbound marketing, followed by sales initiatives, are usually the weak link in many organizations. Axia spends a good deal of time with our portfolio companies assisting management in developing their sales and marketing assets, developing defensible strategies to pursue new markets, etc.’‘

One important source for finding the right people to develop the right strategies to grow a business is the often-ignored executive board.

‘‘When we invest in a company, one of the first things we do is build a professional board,’‘ says Axia’s Hunter. ‘‘They’re not just for corporate governance. Their primary role is to bring advice to help the company grow. We spend a lot of time finding people with technical and strategic knowledge – perhaps not in the company’s existing product line or market, but close enough to add value to the CEO and the management team…It’s always a challenge for the entrepreneur to do that because in many cases they don’t want to take advice, and they worry about giving up control. It’s hard to overcome the ‘its my baby’ position.’‘

Financial advisors are not uncommon candidates for executive boards, thanks to their ability to identify opportunities and guide the company to equity for recapitalization. In today’s tumultuous credit market, small to medium-sized companies may be worried about the costs of recapitalization, but those worries are likely unfounded.

‘‘For the most part, the credit crunch is affecting the large buy-out funds that borrow billions of dollars from hedge funds and institutions,’‘ Hunter explains. ‘‘Though we are starting to see a trickle down effect as larger buy-out funds go further downstream to find financing, small to medium-size companies typically work with regional banks and they have not been impacted by what’s happening in the broader credit environment.’‘

Funding new hires, new products, and marketing and sales expansion is critical to any growth strategy, and brings up questions of long-term strategies, ‘end games’ and transitions.

When a company owner is looking to retire, they have several options: close the company, pass off some portion of ownership, sell part or all of the company, or go public.

Closing and passing ownership to family or partners is fairly straightforward with the final deal structured based on what responsibilities and revenues each part expects to receive. Selling a company or going public are not so easy and require careful planning and preparation.

For instance, according to Axia’s Hunter, annual revenues of $10 million per year and growth projections in excess of 10% are important if a business owner hopes to be able to sell their company. ‘‘Proving growth is one of the most important barometers a potential buyer wants to see. You need at least a three-year track record and reasonably blue skies going forward. Those companies can generally yield a favorable exit. On the other hand, companies growing under 5% in stagnant or low growth markets with limited IP and management strength are less attractive. Buyers want to see how you differentiate yourself, and how they can invest or buy the company and grow it.’‘

Private equity firms like Axia are one way to recapitalize a company for growth; however, the owner needs to realize that the investors need a reasonable return within a reasonable time frame, often defined as 5 years. ‘‘In many cases, Axia looks for companies with owners that want ‘two bites of the apple.’ They sell a share of their company to a private equity firm, who also invests additional funds to grow the company, and ultimately all shareholders get another bite when the entire company is sold. Our portfolio companies are growing at rates between 20 and 50 percent annually.’‘

For the most ambitious companies with strong growth potential, public equity or taking the company public through a stock offering, is a fourth way to grow a business without exiting the market. ‘‘Going public is not an exit strategy,’‘ explains Cognex’s Testa. ‘‘It means you are committed to growing the company. It requires more effort rather than less. Today, there are all kinds of expenses associated with being a public company that add to the cost of management.  For this reason, many venture capitalists, at least in high tech, are no longer targeting an IPO when they invest in a company...they are trying to build the company for sale to a larger entity.’‘

Building a company from scratch to a multi-million dollar corporation is a great achievement by any standard. The question becomes, ‘what’s next?’ Although statistics show that most entrepreneurs have difficulty moving beyond $10 million in annual revenues, the truth is that most companies achieve growth through common practices and strategies with success governed by the ability to develop and implement a cohesive, yet flexible, corporate growth plan.

‘‘Remember, the success of a company today has a lot to do with mapping the direction for tomorrow,’‘ Hunter concludes.

This article was written for AIA by Winn Hardin, director of the technology marketing agency, the HardinGroup (www.HardinGroup.com). Winn can be reached at [email protected].