Lillian Vernon, Sharper Image Crash. Why?

Two entrepreneurs who started off on the wrong foot

February 2008 By Denny Hatch

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The king of high-end tchotchkes (Richard Thalheimer, former CEO and chairman of The Sharper Image) and queen of low-end tchotchkes (Lillian Vernon) have been dethroned.

Lillian Vernon and Sharper Image—two iconic catalogs—were known to have been struggling in recent years.

Their bankruptcies were expected.

That they were announced on the same day is astonishing.

How could this happen?

Both Vernon and Thalheimer launched businesses without paying their dues.

Ultimately, neither of them knew what the hell they were doing.

Lillian Vernon’s Story
In 1933, Lillian Katz’s family fled the Nazis. They left Leipzig, Germany, for Amsterdam, and four years later were lucky enough to catch a ship to the United States.

Fast forward to 1951. Living in a small apartment and using her kitchen table as her desk, Katz took $2,000 of wedding gift money and placed a small ad in Seventeen magazine selling a purse and belt with free monogramming. Her $495 investment in ad space generated 6,450 orders and $32,000 in sales.

(The $495 ad that launched Lillian Vernon is illustrated below. Alas, I could not find the ad that launched The Sharper Image.)

From the first thrill of seeing stacks of envelopes containing cash money through the next half century, Lillian Vernon was passionate about her business, growing it into a behemoth.

Her corporate and personal moniker, Lillian Vernon, was a combination of her first name and the last name of her hometown, Mount Vernon. Over more than 50 years, 5-foot-1-inch dynamo Lillian Katz Vernon built a mail-order powerhouse, moving from space ads to catalogs that averaged 96 pages and 700 items. Retail and outlet stores followed, and in 2001, her Web site was launched. She was able to get inside the heads of her customers—think like they thought, feel what they felt—and offer merchandise that they bought and bought and bought.

The Harvard Business School Web site includes Lillian M. Vernon (Katz) in its list of 20th Century Great American Business Leaders along with Warren Buffett, George Eastman, Marshall Field, Henry Ford, Howard Hughes and Henry R. Luce.

From 2001 to 2003 the company struggled, losing more and more money.

Since neither of her sons wanted to take over the $250 million-a-year business, in July 2003—at age 76—Lillian Vernon sold the company to a private equity firm. The sale price: $60.8 million. The new owner immediately ordered a new business plan that would ratchet up the corporate gifts division, and hired a consultant to oversee this new operation. They could not make it work.

Three years later, in July 2006, Lillian Vernon was sold to another private equity company. The new president—Michael D. Muoio, an alumnus of Vernon competitor Miles Kimball—told The Virginian-pilot’s Bill Tiernan that the company had lost $25 million a year under the previous owner, who sold it off for a paltry $10 million. Muoio was unable to turn the company around.

Lillian Vernon filed for bankruptcy last week.

Richard Thalheimer’s Story
In 1977, Richard Thalheimer, then a young office supplies salesman and occasional lawyer, used to jog in San Francisco and keep track of his progress on a wristwatch that had been specially designed for runners. All who jog should have this item, Thalheimer reasoned. So he cut a deal with the manufacturer and had designer Steve Sugar craft an ad offering the watch for sale in Runner’s World under the corporate moniker The Sharper Image. The ad generated $300,000 the first year, and the rest is history.

Over the next 30 years, Thalheimer created a business that offered a collection of high-tech and electronic items via myriad catalogs, and later in 184 dedicated retail stores. At the end, the catalogs represented only 10% of The Sharper Image business.

To get away from buying product wholesale and selling retail, he opened a research-and-design idea factory where house engineers and designers created some 15 products a year, taking them from the drawing board to the factory (usually in China). By creating his own products, Thalheimer could control costs every step of the way, set his own prices and make the full profit.

The Sharper Image has a polyglot inventory line. Current best sellers include:
* The Ion Audio USB Turntable that converts vinyl records to CDs and MP3s ($199.95)
* Noise-Cancellation Headphones at half the price of Bose ($149.95)
* Roomba 560 Vacuuming Robot ($349.95)
* R2-D2 Interactive Droid ($129.95)

But Thalheimer got into trouble. For example, he made a pile of money with his Ionic Breeze air purifier, which according to The New York Times, accounted for 25 percent of his sales. Two million were sold at $350 each. Then in April 2005, Consumer Reports bashed the product, saying it did not clean air and actually released unhealthy levels of ozone.

Not only were sales hurt, but also the image of The Sharper Image.

After many months of declining sales and losses, Thalheimer was ousted as CEO in September 2006. His two replacements were not able to get the company back to profitability. With $199 million in debt and assets of $251.5 million, the towel was finally thrown in last week.

Sharper Image stock tanked to 47 cents.

How could Lillian Vernon and Richard Thalheimer go so wrong?
The late Joan Throckmorton said this:
As direct marketers, we’re not here primarily to make a sale; we’re here to get a customer. Sales are important, of course. (Where would marketers be without them?) But the name of the game is repeat sales rather than one-shots. And to have that, you need a customer.

Richard Thalheimer and Lillian Vernon started out as kids with no schooling in direct marketing. Both tested single products using space ads, and both had huge successes with their first shots.

Both started by selling tchotchkes—amusing little stand-alone impulse items. Both founded businesses based on finding more tchotchkes and selling them to their original demographic group.

In the end, Lillian Vernon had 3 million buyers whose average order was $56, while the average sale to the 293,000 Sharper Image catalog buyers was $185.

Why people buy
People buy for three reasons:

* Price. Wal-Mart has become the largest corporation in the world (equal to the GDP of Poland) because it is seldom—if ever—undersold.

* Service. If an organization is a joy to do business with—helpful staff, ironclad guarantee, easy return policy and great customer satisfaction—people will pay a little more to do business there.

* Exclusivity. If a buyer really wants a specific item—Glenlivet Single Malt, Hermes, Rolls-Royce, Rolex—the guy who stocks it will get the order.

Go to the Lillian Vernon Web site and you will find the same kind of stuff that is being offered by Miles Kimball, Potpourri Gift, Carol Wright Gifts, The Paragon, Harriet Carter, Walter Drake, Signals, Target and Wal-Mart—cutsey-poo, low-end tchotchkes for home, for storage and organizing, for holidays, for garden and outdoor, for the kitchen.

Quite simply, Lillian Vernon does not offer exclusive merchandise, nor the lowest price, and her service is probably perfectly OK, but so is that of the competition.

Same thing with The Sharper Image.

“Should you ever find yourself in conversation with Richard Thalheimer, it’s best not to get him started on the subject of nose-hair trimmers,” wrote Joshua Hyatt in FORTUNE: Small Business. “As it turns out, they’re the one gizmo (aptly called the TurboGroomer 2.0, $59.95) that the CEO and founder of The Sharper Image says embodies the retailer’s 25-year history.”

Oh, yeah? I once did detailed analysis of all the SKUs in the SkyMall catalog that is found in airline seat pockets and has pages from a slew of upscale existing catalogs (including The Sharper Image). I found seven different nose-hair clippers. They constituted the most popular item in the book with the exception of wristwatches.

When Peggy and I sold our newsletter and moved to Philadelphia, we decided to buy ourselves a CD player that would attach to our Bang & Olufsen stereo rig. We bought a nifty, high-tech, stand-alone model. A couple of years later I was stopped cold by a stereo in The Sharper Image catalog that looked like a clone of our B&O set for a fraction of what we paid.

In short, much of Thalheimer’s glitzy merchandise were knockoffs. He rode the high-tech wave for a number of years, but—like Lillian Vernon—he got competition. Suddenly he was running in a pack, along with Brookstone, C. Crane, Crutchfield, Herrington, Improvements, Hammacher Schlemmer, Radio Shack, Wal-Mart, Target, Best Buy and Circuit City.

Experienced direct marketers are inculcated with the Joan Throckmorton business model—profitability only comes with repeat sales. For example, I cut my teeth in the book club and continuity businesses where each order represented multiple sales.

Same thing when I became a freelance junk-mail writer—and later a newsletter publisher. My main business was paid circulation. A new subscription lost money or—if you were lucky—was a breakeven proposition. Only with renewals—selling the existing customer another year—do you start making money.

“It turns out that buyers of R2-D2 Interactive Droids ($129) are not the best repeat customers,” wrote Michael Barbaro in The New York Times. “That left The Sharper Image struggling for an identity in consumer electronics, a product line that is among the most competitive in American retailing.”

Always have a USP (Unique Selling Proposition)
Lillian Vernon started out with a USP: free personalization. It was her hallmark for 50 years.

When she sold out to the first private equity firm, the nitwits trashed the brand and started charging for personalization. When the company was sold at a distressed price to another private equity firm, new CEO Muoio reinstated the free monogramming policy, but it was too late.

Had the company stayed true to its USP and offered a full line of imprinted and personalized merchandise—women’s clothes, men’s shirts and cuff links, napkins, paper goods, fine and costume jewelry, corporate premiums and gifts, leather diaries, etc.—the business may have lasted beyond 56 years.

Instead, the business was built on tchotchkes, and found itself running with a pack.

The selling proposition was no longer unique.

Create Dependency
Richard Thalheimer’s USP was initially exotic, up-market electronics and fascinating gizmos. But he had no sense of the concept of line extensions.

For example, if you offer a CD stereo rig, make sure the buyer becomes dependent on you for CDs to play on it so that you get ongoing revenue rather than a one-shot sale.

If you sell DVD players, offer the greatest selection of DVDs ever assembled—or cut a joint venture with Blockbuster or Netflix—so that you receive continuing income from that initial sale.

All Thalheimer’s sales were single shots. He never gave customers a good reason to buy more and more and more.

“One book is an item,” said Richard Simon, founder of the great publishing firm of Simon & Schuster. “Two is a line.”

Lillian Vernon and Richard Thalheimer never had lines; they sold items. In the beginning they were unique.

They no longer are.

One final thought: Thalheimer was thrown out after running the business for 30 years, and three successors failed to stanch the red ink. When Lillian Vernon decided to bail out after 50 years, her planning was so poor that the business she created and built with such passion wound up in the hands of private equity firms—which wrecked it. Bill Gates has Steve Ballmer. Who did Richard Thalheimer and Lillian Vernon have?

Nobody.

When an entrepreneur creates a business and runs it for 30 of 50 years with no logical succession in place, you are looking at a temporary winner and an ultimate loser—who most likely has an ego problem. From Carolyn Shapiro’s story in The Virginian-pilot, December 23, 2007:

Lillian Vernon, a 56-year-old retailer that specializes in personalized products sold via catalog and Internet, typically adds about 3,000 seasonal workers to its core staff of about 800 to handle the flood of holiday business. By the end of December, the company lets go those extra workers, and many arriving at the headquarters Friday afternoon said they came to pick up their final paychecks. The termination of year-round employees at this time, however, came as a surprise to many ... [Alice] Powell said the terminated workers were prohibited from returning to their desks. Supervisors brought them their belongings and escorted them out of the building immediately after they were given notice. Some of the laid-off employees had worked for the company for almost 20 years, Powell and [Virginia] Hudgins said. They said they would receive two weeks severance pay from the company if they signed a termination letter. They added that the company would avoid paying them their typical holiday bonus: two paid days off on Christmas and Christmas Eve.