Zytec Corporation

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Zytec Corporation

7575 Market Place Drive
Eden Prairie, Minnesota 55344
U.S.A.
(612) 941-1100
Fax: (612) 829-1837
Web site: http://www.zytec.com

Public Company
Incorporated: 1984
Employees: 2,300
Sales: $228 million (1996)
Stock Exchanges: NASDAQ
SICs: 3679 Electronic Components, Not Elsewhere Classified

Zytec Corporation is a leading designer and manufacturer of power supplies, which convert, distribute, and regulate the electricity needed to operate computers, peripherals, office equipment, and communications technology. The Minnesota-based company is one of the largest power supply producers in the United States and has earned a reputation for quality within the industry and with the high-tech original equipment manufacturers which are its customers. A smaller but growing portion of Zytec’s business comes from its power supply service and logistics operation.

Roots with Control Data Corporation

In the mid-1960s, as part of its vertical integration strategy, Control Data Corporation (CDC) opened a power supply plant in Redwood Falls, Minnesota, a small town about 100 miles southwest of Minneapolis. The factory produced power supply units for CDC subsidiary Magnetic Peripherals Inc. (MPI), which manufactured large magnetic disk drives. Engineering, purchasing, inventory control, and production schedules for the Redwood Falls plant and other small-town “feeder plants” manufacturing components and subassemblies for CDC were centralized in the Twin Cities.

In the early 1980s, CDC was faced with rapidly advancing electronics technology and intense competition in the market-place. In response, CDC implemented a new business strategy. The company began to sell off its low-tech manufacturing operations—such as power supply units, cables, and circuit boards—and turned its resources to product development. From a different perspective, the community of Redwood Falls was at risk of losing its largest employer (the plant had once employed more than 500 people), when the region was already being rocked by an agricultural crisis.

CDC offered to sell the plant to a long-time employee, peripheral products manager Ronald D. Schmidt. His initial response to the idea was negative, but he became interested in acquiring the company when he was assigned to work on a plan to jointly operate the power supply operation with another large computer company. When the joint venture failed to materialize and a buy out offer made by plant employees was rejected by CDC, Schmidt asked John M. Steel, another peripheral products manager, and Lawrence J. Matthews, head of component development at Magnetic Peripherals, to enter into a leveraged buy out of the plant.

CDC invested $500,000 for 22 percent of the company: an investment to be phased out over a three-year period through a discounted employee repurchase of stock. Schmidt, Steel, and Matthews raised $200,000, and CDC’s financial subsidiary, Commercial Credit Co., kicked in $5.5 million in financing. Production would continue in Redwood Falls with the management and engineering offices located in the Twin Cities. Zytec was incorporated in January 1984 with Schmidt at the helm. Initially, CDC continued to provide Zytec with purchasing, inventory, and some corporate support services as well as orders for power supplies.

The Difficult Path to Independence

Schmidt, Steel, and Matthews planned to broaden their business by diversifying into other power supply markets, including minicomputers, engineering workstations, telephone switches, medical testing and diagnostic machines. The new owners also made a commitment to use Dr. W. Edward Deming’s 14 points for management—a philosophy which often received credit for reviving Japan’s post-World War II economy—as a frame-work for making manufacturing changes. In the meantime, the newly independent company was operating under increased demand, while working to establish its own purchasing and production systems and building a warehouse for inventory. Nearly all of Zytec’s first year revenues of $66 million were generated from its business with MPI.

The optimism associated with its initial surge of growth and plans for the future was squelched by a dramatic slump in the computer industry and existing manufacturing problems. Zytec began 1985 with $11 million in parts on its shelves and $6 million in unfinished product in the plant. Cycle times—the time from introduction of materials on the plant floor to shipment of product—were getting longer and cutting into already slim profit margins.

In the midst of the developing crisis, Schmidt worked to familiarize managers with Deming’s concepts. He also brought on board people who were experienced in implementing Statistical Process Control (SPC) and Just-In-Time (JIT) manufacturing techniques: SPC involved the continuous monitoring of the production process in order to identify problems quickly, while JIT involved introducing and moving materials through the manufacturing process with maximum efficiency. Zytec also adopted a Total Quality Commitment (TQC) management approach which gave all employees some level of responsibility for establishing, tracking, and achieving production goals and objectives.

However, in June 1985, after several earlier cutbacks on new orders, MPI abruptly stopped all shipments. The computer industry had weakened, and sales on CDC’s large disk drives had plummeted even further. Production at the Redwood Falls plant was completely shut down for two weeks. Zytec gradually resumed operation, with employees taking salary cuts of 10 to 20 percent. According to George Dixon in Corporate Report Minnesota, “Later that summer Control Data slowly began to place more orders. By then, however, Zytec had begun to get its ruinous inventory and work-in-progress problems under control.” They survived the period, according to Schmidt, by living off their inventory. Sales for 1985 had fallen to $48.5 million with losses of $2.3 million.

Reorganization and Renewal

Zytec’s revamping was put into full gear in 1986. Employee training was accelerated. The factory was reorganized into manufacturing cells to streamline the production process. Quality control techniques were integrated into corporate areas as well as on the manufacturing floor and in the warehouse. Zytec returned to profitability in 1986, but revenues were still falling and the vast majority of orders were still coming from CDC.

San Francisco-based Micro-Tech Consultants, which served the power supply industry, estimated 1986 sales by independent producers to be more than $1.6 billion. With approximately $45 million in sales, Zytec was ranked seventh among U.S. firms. The industry consisted of many small producers with access to the same basic technology, operating under few industry standards, and most often producing custom made power supplies for a single large customer.

Power supplies, an essential element of electronic equipment, basically did the following: switch alternating current (AC) to the direct current (DC) used by electronic systems, provide various levels of DC voltage to subsystems and components, and monitor and regulate voltages to protect the equipment from power surges. However, the stress on the product caused by continuous use, the high level of manual construction, and the dearth of investment in technology had saddled the power supply industry with a reputation for product failure.

Recognition for Quality

By 1987, Zytec was gaining notice, not for its failures but for its successes. The manufacturer had become more competitive with overseas power supply producers in terms of cost, quality, scheduling and delivery times. Currency exchange rates had also started to favor domestic businesses. It gained such customers as Fujitsu America, Tandem Computers Inc., Unisys Corp., Abbott Laboratories, AT&T, IBM, Eastman Kodak, Net-work Systems, Sun Microsystems, and Storage Technology. Zytec continued to refine its operations, invest in technological advancements, and diversify its markets over the next few years.

In 1991, Zytec won the Malcolm Baldrige National Quality Award, the Minnesota Quality Award, and the IBM Market Driven Quality (MDQ) Gold Award. The privately held company’s revenue grew by nearly 30 percent in spite of a recession. Zytec also expanded internationally with the acquisition of an Austrian power supply manufacturing plant.

Company Perspectives:

“We are a company that competes on value; is market driven; provides superior quality, service and value; builds strong relationships with our customers; and provides technical excellence in our products. We are action oriented and willing to innovate; foster integrity; autonomy and entrepreneurship; and believe in the importance of execution. We believe in a simple form and a lean staff; the importance of teamwork, mutual trust, involvement, and people as individuals; and the development of productive employees through training, education and capital investment. We focus on what we know best thereby making a fair profit on current operations to meet our obligations to all stakeholders and to perpetuate our continued growth.”

By the beginning of 1992, Zytec had 21 customers; less than five percent of business was with CDC. Zytec planned to go public that year, but the initial public offering was canceled due to inconsistent earnings coupled with an unfavorable market for smaller companies. Zytec did win another honor: Industry Week magazine named the Redwood Falls plant one of “America’s Ten Best Plants.” David Altany of Industry Week said Schmidt’s and Zytec’s commitment to Deming’s quality principles set them “apart from the pack.” Nevertheless, the company’s bottom line was still wavering: Austrian operations lost nearly $4.5 million and largely contributed to the year-end loss of $3.3 million.

Zytec finally went public in November 1993. The stock was sold at $10.375 for a total of $9.2 million. The Austrian plant still generated a small loss in 1993, but the company’s earnings were on an upswing. Zytec-designed and collaborative power supplies, the product segment with the highest profit margin but the longest development time, brought in 78 percent of revenues in 1994. Customer-designed power supplies, a low-risk and low-margin segment of business, contributed 13 percent of revenues. The remaining nine percent was generated by the repair and service end of the business. Zytec’s power supply repair operation was the largest in the United States: they handled the products of more than 200 manufacturers. The bulk of the service business was dedicated to one customer, Hewlett-Packard, via Zytec’s California repair facility. Overall, Zytec’s revenue for 1994 grew by 41 percent to $128 million.

Dynamic Forces Affect Zytec and the Industry

In the mid-1990s, the power supply market remained highly fragmented with over 350 manufacturers. According to a 1995 John G. Kinnard & Co. report, two industry trends were likely to benefit Zytec. Many original equipment manufacturers—which accounted for about half of the power supply market—were shutting down their internal power supply operations finding it more economical to purchase the product rather than to manufacture it themselves. In addition, as power supplies became more complex and the industry became more automated, increased design and capital costs made it more difficult for the smaller independent power supply manufacturers to be competitive. Only a small percentage of U.S. manufacturers—Zytec among them—had annual revenues of more than $100 million while the vast majority of U.S. power supply makers had annual sales of less than $10 million.

A different trend in the electronics industry, one of demand outstripping capacity, had a negative effect on Zytec in 1995. A shortage of power semiconductors shut down production on several key projects early in the year. Zytec compensated by seeking out additional suppliers and redesigning some products, but the supply problem kept year-end earnings down in spite of significant revenue growth.

Schmidt, Steel, and Matthews, the leaders of the buy out from CDC, still owned about 35 percent of the company in 1995; other employees owned an additional 10 percent. Since the IPO, Zytec stock had hovered around the initial offering price, but in 1996 the stock experienced some volatility: first, due to earnings estimates and then later because of an online bulletin board notice. Other activity included two stock splits and a postponed public offering.

The opening of a new manufacturing plant in Broomfield, Colorado, and an expansion of the plant in Redwood Falls helped alleviate Zytec’s capacity problems. Zytec also acquired a magnetic components plant, the primary supplier for its Austrian operation, from the Hungarian government in 1996.

Zytec’s 1996 revenues were $228 million. Net income rose 103 percent—if excluding a one time tax gain—to $7.9 million. In its 1996 10-K report, Zytec contributed its recent surge in sales to sole-provider opportunities with original equipment manufacturers for the Internet and data communications marketplace. Zytec also reported that its service and logistics business had been doubling each year, and the company was seeking additional customers in that growing area.

Future Directions

More complex electronics technology has driven the need for smaller and more efficient power supply systems such as the ones Zytec manufactures. They have hundreds of components and perform advanced diagnostic and power management functions. In 1996, Zytec established a distributed power architecture (DPA) office in Richardson, Texas, in 1996. DPA is a process which allows greater flexibility when adding electronic components or upgrading hardware. The developing technology had been commonly used in telecommunications and was finding expanded applications in data networking, large volume data storage, and high-end data processing markets. Based on industry forecasts, Zytec expected the DPA technology to be an important expansion of its business in the future.