Babbage’s, Inc.

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Babbage’s, Inc.

10741 King William Drive
Dallas, Texas 75220
U.S.A.
(214) 401-9000
Fax: (214) 401-9002

Public Company
Incorporated: 1983
Employees: 2,400
Sales: $233.4 million
Stock Exchanges: NASDAQ
SICs: 5734 Computer & Software Stores

Babbage’s, Inc. is one of the largest consumer specialty software retailers in the United States, operating a chain of more than 300 stores, virtually all of which are located in regional shopping centers. Specializing in programs for home entertainment, productivity, and educational use, Babbage’s outlets sell software in cartridge, floppy disk, and CD-Rom formats, supporting more than a dozen major personal computer and video game system platforms. Babbage’s product line consists of over 1,400 items, which generally sell for below manufacturers’ list prices. Major brands of video game systems, game software, and other entertainment software for personal computers represent about two-thirds of the company’s sales. The company also sells computer accessories and supplies.

Babbage’s, named for Charles Babbage, the nineteenth-century British mathematician generally credited with inventing the first major forerunner of a computer, traces its roots to two Harvard Business School classmates, James B. McCurry and Gary M. Kusin. At Harvard during the mid-1970s, McCurry and Kusin discussed going into business together but went in separate directions after graduation; McCurry became a consultant for Bain & Company’s San Francisco office, while Kusin became a Dallas-based general merchandise manager for the Sanger-Harris division of Federated Department Stores. In 1982, Mc-Curry approached Kusin with a business proposal to establish a chain of software stores that would capitalize on the burgeoning computer and home video game industries. His idea was based on the expectation that increasing consumer interest in computer equipment and games would make the specialty store the ideal marketing outlet. Kusin, who had been watching such specialty stores gradually take over department store business, liked the idea, and, at the end of the year, both men quit their jobs and began seeking startup financing for a software business.

McCurry’s and Kusin’s business plan met with little interest among venture capitalists until February 1983, when businessman Ross Perot—who knew Kusin’s family in Texarkana— offered to provide a $3 million credit line in exchange for one-third ownership in the company. Perot also advised the entrepreneurs to shelve their plan for immediately opening 20 stores in favor of establishing one outlet, which they would manage themselves until they knew the business inside and out. McCurry and Kusin took Perot’s money and advice, and, on Memorial Day 1983, they opened the first Babbage’s store in a Dallas regional mall. McCurry, the company’s chairperson, managed the company’s finances, while Kusin, the company’s president, acquired software products from local distributors. Both partners took turns opening and closing the store and seeing to other administrative details.

During this time, McCurry and Kusin tested their business strategy, which involved four key provisions: a constantly updated mix of products, a competitive pricing system, a flexible store design with sections devoted to various computer and entertainment system platforms and software categories, and an enthusiastic, noncommissioned sales staff that would not intimidate customers with technical jargon. Two months after opening the first Babbage’s store, McCurry and Kusin met their sales projections and hired their first full-time employee, Mary Evans, who later became vice-president of stores. Between Labor Day and Thanksgiving of 1983, Evans helped open and manage four more Dallas-area stores.

Babbage’s set a precedent of selling entertainment software for the most popular computer and video game systems; at the time, the dominant home video game system was the Atari 2600, which featured four-color graphics. Eventually Atari was superseded by Nintendo and Sega of America systems, and Babbage’s redirected its product line accordingly.

In 1984, Babbage’s first full year of operations, the company lost $560,000 on sales of $3 million. Two years later, it broke even after generating nearly $10 million in revenues from an expanded chain of 23 stores, financed through the private sales of company stock. In 1987, Babbage’s added another 35 stores and began selling software for the then-dominant eight-bit Nintendo Entertainment System with 16-color graphics. For fiscal 1987, the company earned $1.16 million on sales of $29 million.

In July 1988, Babbage’s took its software specialty store concept public, offering 30 percent of the company’s equity for $20 million, or $13 a share. Following the public offering, Perot tendered his stake in the company, and Babbage’s continued accelerating its expansion drive with the proceeds of stock sales, opening 50 new stores that year to give the company 108 retail outlets. This expansion resulted in rising sales; in 1988, Babbage’s annual revenues doubled to $58 million, while earnings shot up 136 percent to $2.7 million.

In 1989, Babbage’s began losing business due to severe allocations of video games. Struck by a string of losses in the first three quarters of the year, the company responded by reducing prices on leading computer software titles and adding new cartridge-based video games to its line. Moreover, in the fall, Babbage’s helped introduce the new 16-bit, 64-color Sega Genesis entertainment system, which quickly changed the landscape of the video game industry. Because of its superior capabilities, Sega Genesis generated a renewed interest in home video game systems. Rising sales of entertainment systems and software contributed to a strong 1989 holiday sales season for Babbage’s, as the company managed a $2.3 million profit on annual sales that increased 62 percent to $95 million.

Fifty-three new store openings in 1989 (bringing the company’s total to 160) and a barrage of new, low profit margin products pushed the company’s earnings and its stock’s trading value down. By early 1990, Babbage’s stock, which had debuted at $13, had plummeted to less than $5. Babbage’s responded to its financial troubles by scaling back the company’s expansion program—opening only 19 stores in 1990—and focusing on cost-control measures and improved inventory turnover. Moreover, a new computerized point-of-sale inventory system was established, tracking sales and inventory after each business day and automatically generating orders for shipment from the company’s Dallas warehouse the following morning. Powered by a surge in video game systems and software—including Sega’s 16-bit Genesis and Nintendo’s hand-held Gameboy player—the company’s revenues rose 39 percent to $132.8 million in 1990 as earnings increased to $4.1 million.

Opal P. Ferraro, who joined Baggage’s in 1986 as controller, was named chief financial officer in 1991, and, two years later, Ferraro joined McCurry and Kusin as the only other company officer on Babbage’s board of directors. With the company in improved financial shape, Babbage’s boosted its number of stores from 178 to 204, and reported 1991 earnings of $5.58 million on sales of $168.3 million.

In 1992, Babbage’s added more than 40 new stores and began selling a CD-ROM peripheral attachment for the Sega 16-bit system that allowed interaction with digitized video footage. Sparked by a price war in the computer industry, sales of IBM-compatible software and 16-bit video systems and software rose substantially, and the company’s stock value increased accordingly, climbing to more than $24 per share. The company’s earnings also increased 21 percent to $6.78 million, and sales jumped 24 percent to $209.1 million.

In the fall of 1993, Babbage’s began selling Panasonic’s 32-bit game system, which operated through compact discs. This new technology threatened to render the 16-bit systems obsolete, and Babbage’s experienced rapid declines in its sales of video game systems and software during the Christmas season, with the average Babbage’s store posting five percent lower sales than a year earlier. Realizing that the market for 16-bit technology had matured, Babbage’s slashed prices on hundreds of video game titles early the following year, in an effort to unload its inventory of the increasingly dated software.

In 1993, Babbage’s opened 56 new stores. However, the company generated only a 12 percent increase in sales, and, for the first time since 1989, increased revenues did not translate into higher earnings for the company. Earnings fell 36 percent to $4.3 million that year, as entertainment software continued to comprise about two-thirds of Babbage’s business. Education and productivity software, along with computer supplies and accessories, cumulatively accounted for the remaining third.

Babbage’s entered 1994 with a 300-store chain and plans to open between 30 and 40 more stores that year. As a result of holiday season price reductions, Babbage’s stores had substantially reduced their inventory. However, the company was in a stronger financial position, as it had no long-term debt and maintained a cash surplus of $10.5 million. Babbage’s entered the mid-1990s facing increasing competition from other software specialty stores, mass merchandisers, computers centers and superstores, electronics stores, toy stores, and mail order outlets, many of which were larger operations and had greater resources at their disposal. Nevertheless, Babbage’s remained confident that its broad product selection, competitive prices, and customer service would continue to draw customers into its stores.

The company expected a continued decline in sales of video game systems and software in the near term, until the next generation of entertainment systems and programs were introduced. Those planned introductions included the late 1994 release of a 32-bit Sega system and Nintendo’s promised debut of a 64-bit system, expected in 1995. Babbage’s expected entertainment software to continue to comprise the fastest growing part of its business, and that developments in multimedia systems utilizing the CD-ROM format would bolster sales. While the market for interactive software was still evolving in 1994, Babbage’s believed the potential for growth in that market was substantial and hoped that as such software moved closer to what is known as “virtual reality,” more adults would be drawn into the market for entertainment software. Babbage’s also appeared well positioned to benefit from the anticipated expansion of the market for home computer software stemming from trends in personal computing, including price wars among computer manufacturers and the rise in the number of households owning computers or upgrading their systems.