Advanced Visual Systems

By March of 1997, Harry Cochran had just completed his first two months as the new
president and CEO of Advanced Visual Systems, Inc. (AVS), based in Waltham, Massachusetts.
AVS developed and sold high-end data visualization software that allowed massive quantities of
data to be transformed into informative two- and three-dimensional (2D and 3D) graphical
representations.

The heritage of AVS hearkened back to 1988 in the software development laboratories of
Stardent Computer, Inc. as an effort to understand and capitalize on the emerging market for 3D
visualization software. With a focus on computer hardware, however, the management of
Stardent did not want to be distracted with the intricacies and risks of software development and
marketing. It therefore allowed the software development team to spin out the 3D software
division. In January of 1992, this new enterprise was spawned as AVS.

The company initially enjoyed tremendous growth. By 1994, sales were over $17
million, but after only modest growth in 1995, sales in 1996 had dropped back to 1994 levels.
(See Exhibit 1, Financial Statements and Exhibit 2, Revenue Analysis). AVS seemed to have
hit a ceiling in spite of the high esteem it had earned in the marketplace. It was up to Cochran to
put the company back on track.

Graphic Visualization Software

Visualization software was used by technical and business professionals who recognized that
if they could transform large data sets into useful information, they would accelerate the
understanding of complex problems, and that whoever made the most effective use of this asset
would have an enormous competitive advantage. In 1992, most of these end-users were
engineers using expensive and sophisticated systems in large government and industry computer
laboratories.

Accordingly, the first product developed by AVS was AVS (Application Visualization

David Wylie, director of Babson College Case Publishing, prepared this case with the assistance of Professors William
Lawler and Ken Matsuno, Babson College, as a basis for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation.
Copyright © by David Wylie, William Lawler, and Ken Matsuno 1997 and licensed for publication to Harvard Business
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Advanced Visual Systems, Inc. BAB001

System), designed to facilitate scientific research that was sold directly to these large laboratory
users. Since often these users relied on either internal or external software developers to create
applications customized to their needs, AVS also created an application development product
called AVS/Express: a multi-platform, component-based software environment for building
applications with interactive visualization and graphics features. AVS/Express employed an
innovative object-oriented visual programming interface to create, modify, and connect
application components. It provided object kits that contained numerous building blocks for
constructing visualization applications and application components such as graphics display,
image processing, and geographic rendering. AVS engineers also developed a version of
AVS/Express called VIZ Express for end-users.

The landscape, however, was changing in the mid-1990s. With the cost of 3D-capable
computers falling below $3,000 and the proliferation of 3D-enabled web browsers and interactive
visualization software, the available market for high-performance 3D solutions was expanding
exponentially and influencing the way in which business and technical professionals viewed and
analyzed data. Increasingly complex and voluminous data were overwhelming traditional
analysis techniques such as spreadsheets, simple charts and graphs, and two-dimensional static
pictorial representations. In a rapidly expanding set of disciplines, these conventional methods
were being supplemented with, and in many cases supplanted by, more sophisticated
visualization techniques that permitted more sophisticated data analysis such as that offered by
AVS.

Visualization was thus becoming an increasingly important tool in a number of industries.

An oil exploration company, for example, interpreted 3D seismic surveys to pinpoint more
effectively the location of promising oil deposits. A telecommunications company used multi-
dimensional relationships to determine the best
location for cellular telephone receivers. A
End-users of AVS Software
defense contractor took data from multiple
sources (e.g., satellite imagery, aircraft telemetry, Geospatial
etc.) and built an integrated visual command- Defense/intelligence 5%
and-control system. The same Oil and gas 15%
telecommunications company used customer- Environmental 10%
related multi-dimensional relationships to Telecommunications 7%
analyze how to retain customers. An engineering Other Markets 20%
company visually analyzed the data collected Data-mining 3%
from simulations to improve design efficiencies Engineering 30%
of circuit boards. A medical imaging company Medical Imaging 10%
viewed gamma camera data more effectively to
provide radiologists with a more accurate
diagnostic tool. A financial services company used advanced visualization techniques to uncover
new customers from large prospect databases.

The end-users of AVS software were a diverse group. In 1996, the geospatial,
engineering, and medical imaging markets represented approximately 77% of the company's
overall business, although the customers who bought AVS products were still mostly software
developers who customized visualization packages and bundled AVS software into final

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deliverables. AVS's developer customers included independent software vendors (ISV's) who
sold their applications to third party end-users, system integrators who built application solutions
for their customers, and internal software development groups who created applications for
deployment to users within their organizations. In all of these cases, application developers
understood end-user requirements and built applications designed to solve their particular needs.
They used either AVS development tools such as AVS/Express as a development framework to
create their own software or end-user products such as AVS to imbed sophisticated visualization
capabilities as components in their software. The most common alternative to using AVS
products was to use traditional development approaches. The primary source of competition for
AVS/Express, therefore, was in-house development.

AVS/Express pre-built graphics and visualization modules thus saved both time and
effort for the developer, which translated to faster time-to-market and thus faster time-to-
revenue. The AVS/Express Developer's Package was sold to developers for $25,000 (UNIX) or
$18,000 (PC). Usually developers also purchased one or two additional developer seats at
$6,000 (UNIX) or $4,000 (PC) per seat. From 1994 to 1996, about 200 developer packages had
been sold at an average of, including additional seats, just over $25,000.

Once a developer completed an application using AVS/Express as the development

environment, it would purchase application seats for each customer who purchased their software
($2,950 UNIX, $1,450 PC quantity at list, less discounts) to deploy the application with
AVS/Express objects embedded. These were known as “run-time licenses.” The expectation
was that this scenario would produce a recurring revenue stream for four to five years.

The run-time license revenue that AVS could garner was thus potentially more important
than the revenue generated from the initial product/developer tool sale. AVS, however, had
failed to reap the full potential of this revenue source. Only about 10% of development projects
actually generated any run-time licenses. Those that did sold from 5 to 50 application seats, or
an average of 20 seats. The price paid for each of these seats netted out to just under $1,000, on
average, after quantity discounts were applied.

Distribution of AVS Products

AVS sold its product through several channels. It sold directly to customers (developers
and end-users), through independent distributors, or through its own subsidiaries. Other software
companies also purchased AVS products to imbed into their own products.

In 1993, AVS had expanded internationally with the acquisition of Uniras, a Denmark-
based supplier of computer graphics products with sales of $11 million. Since its parent
company had gone bankrupt, AVS was able to acquire Uniras at the “fire sale” price of under $1
million. Uniras offered a complementary product line of charting and graphing products,
Toolmaster and Gsharp, and immediate access to the growing European market supported by
established sales and product support teams. Following the acquisition, Uniras’ European offices
became AVS subsidiaries but continued to operate as autonomous divisions of AVS.

By the end of 1996, AVS had established distribution channels throughout the world,

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selling its products primarily through a direct sales force in the United States and through
subsidiaries in Denmark, France, Germany, Italy, and the United Kingdom, and through
distributors in certain other countries. Kubota Graphics Technologies, Inc., which had exclusive
distribution rights in Japan and other Asian countries, had been very successful in selling AVS
products there.

The AVS sales organization in the United States consisted of seven direct sales field
representatives and two telesales representatives. The direct sales people met face to face with
prospective customers, and the telesales representatives telephoned prospective customers,
followed up and qualified leads for the direct sales organization, accelerated order processing and
receipt at the end of the sales pipeline, and contacted existing customers to make follow-on sales.

AVS Operations
Users of AVS software demanded very little support. Indeed, AVS only had two
customer support engineers on staff in the United States. When developer customers asked
questions these individuals could not answer, they were usually referred directly to one of the
twenty software design engineers. Uniras offered support in Europe and Kubota in Japan. While
customers could get their questions answered by highly qualified engineers, the engineers often
complained that the questions distracted them from the focussed attention required of writing
code for new programs.

AVS did offer some consulting services, but since customers were more in touch with the
unique requirements of each vertical market1, AVS had chosen not to have any specialized end-
user industry expertise a priori. Since the gross margin on professional services were quite high
(40%), if a customer wanted some support in their development efforts, typically AVS would
hire a consultant for a specific project. Finding and training a consultant might, however, take as
much as four months before he or she could be productive. For smaller projects, AVS couldn’t
keep up with demand. In 1996, AVS had four full-time consultants who were paid between
$70,000 and $100,000 per year depending on their level of expertise. Consulting services only
contributed about 5% of total revenue (or just under $1 million) in 1996.

The real focus of AVS was to develop continually enhanced tools. Its engineers therefore
focused on making marginal improvements to AVS software. When new versions were
completed, they were turned over to the marketing and sales department so that they could be
used in their sales pitch to potential customers.

AVS had invested over 200 staff-years in development of its products. The company's
core technology and knowledge base in graphic visualization therefore presented a significant
barrier to entry to new competitors.

1
A vertical market refers to a segment of end-user market defined by common industrial technology needs.

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Vertical Markets
Medical Imaging

In 1995, AVS had embarked on a program to target sales directly to end-users in certain
vertical markets. The first such market targeted was that of medical imaging.

In medical imaging the main application areas for visualization included computer-aided
medical diagnostics, image-guided surgery, and radiation treatment planning. Medical
researchers and physicians using imaging applications were able to visualize non-invasive
computer models of the human body. These models helped better detect, measure, and operate
on patients with serious health conditions like cancerous tumors, Alzheimer's disease, epilepsy,
and Parkinson's disease. AVS products were used by a significant percentage of the research
hospitals and the emerging treatment planning segments where 3D imaging was important. The
company had also been quite successful in the medical OEM segment of this market. To date,
the company had over twenty OEM customers.

During 1995 and 1996, AVS had invested over $2 million in marketing, sales, and application
development in medical imaging. It became apparent, however, that the current medical
imaging market potential for visualization software and services was relatively small, estimated
to be $50 million. The biggest competitor in the market sold about $12.5 million, while in-
house development accounted for about $30 million. The remaining $7.5 million was spread
among another six players including AVS. By 1996, this market accounted for only 10% of AVS’s
sales, and the effort to market directly into this market were dropped. AVS’s annual sales in the
medical market were about $1.8 million.

Alternative Vertical Markets

The strategy of entering certain vertical markets, however, was not dropped. With the
experience of the medical imaging initiative behind them, criteria for entering new markets were
developed which included the potential to dominate an application area by achieving a 40%
market share. The other markets under consideration were the geospatial and engineering
markets where a number of AVS products were already being used. Meanwhile, some
consideration was being given to the fledgling, but potentially even greater, market for visual
data mining/data warehouse visualization.

Management estimated that an investment of $2 million would be required to target either

the geospatial or the engineering market. This included about 10 employees at $150,000 apiece
in sales, management, customer support, consulting, and product development, and an additional
$500,000 for marketing. Any consultants who might be added to help new users customize
applications to their specific uses, however, would pay for themselves after a month of training.

Geospatial
The geospatial market consisted of several different vertical markets, some technical and
some commercial, which had in common a compelling need to use sophisticated visualization
techniques to analyze massive amounts of data involving relationships below, on, or above the
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surface of the Earth. In all of these applications, geographically dependent data was analyzed
spatially to provide greater insight about complex interdependencies among the data. Some
examples of these types of visualization applications included remote sensing satellite imaging,
earth resources management, radio frequency propagation modeling, and customer retention
analysis.

By 1996, AVS had already made some inroads in a number of technical geospatial
vertical markets, including defense/intelligence (accounted for 5% of AVS end-user base), oil
and gas (15%), environmental (10%), and telecommunications (7%). More recently, it had
begun to penetrate segments of the high-end business visualization market, initially with
applications delivered into telecommunications and financial services vertical markets.
Opportunities were also arising in companies that needed visualization applications in other
business markets as they began to recognize the value visualization offered. Typical of these
new opportunities were data mining/data warehouse visualization applications for customer
retention and database marketing programs. As had been the case in the technical markets,
providing the business user with a visual framework within which to analyze many variables of
transactional, demographic, and customer purchase data provided a deeper level of insight than
was available with traditional analysis techniques.

Two independent software vendors (ISVs), ESRI and Intergraph, controlled over half of
the geospatial software tools market. The remaining market share was split between eight other
vendors.

New high-resolution satellite data sources were scheduled to emerge into the commercial
market in 1998. The availability of relatively low-cost, high-resolution, ortho-rectified imagery
(geometrically correct) from these new satellites could fundamentally change the nature of the
geospatial market. Intelligent "image maps" could become the standard data set for manipulation
and analysis within a geospatial system. Two-dimensional satellite images that were texture-
mapped and draped over three-dimensional terrain data could become the new geographic
framework.

AVS management estimated that the current market for geospatial visualization software
and services exceeded $100 million. In addition, classified projects from the Department of
Defense/Intelligence community could be at least that amount. AVS sales in the geospatial
market were about $7 million in 1996, although only a fraction of these sales were directly to
end-users.

Choosing the geospatial market seemed attractive. Since there appeared to be some
commonality between the various geospatial applications, the incremental cost to enter each
segment of the market would only be about another $1 million over the $2 million required to
make the initial thrust into a single segment of the market. However, it was uncertain whether
the existence of the commonality was substantive enough. Although $1 million was a relatively
absorbable investment size, AVS management wondered about how to go about verifying the
significance of the commonality.

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Engineering
The engineering market accounted for 30% of AVS end-user sales in 1996. It was
segmented into multiple markets that included major industries such as aerospace, automotive,
and semiconductor. Within engineering, visualization was used in computed-aided engineering
(CAE) and electronic design automation (EDA). Ninety percent of all software sales in this
market were directly to end-users.

In the CAE market, AVS had two types of customers. The first type was comprised of
developers of CAE applications that built post-processors for resale to end-user customers. The
second type of customer were end-users and included major industrial companies, such as Boeing
and Ford, which built in-house post-processors to visualize results from multiple analysis
applications. Integrating all aspects of the design process was a major trend within engineering
markets and this ability to use AVS products to integrate and view results from multiple
applications had tremendous value to these companies. The worldwide market for CAE tools
was estimated to be about $5 billion and growing at 10% per year.

While AVS had no significant share of the $1.6 billion worldwide EDA market (1995), it
counted four major end-users as customers with sales of almost $200,000 in the first two quarters
of 1996. There were several major competitors in this market, the largest of which had tens of
thousands of seats around the world. The EDA market was, however, projected to grow at
almost 17% per year.

The potential for visualization software and services in these engineering markets was
thought to be approximately $50 million, but there were no major competitors. Ninety percent of
all applications were developed in-house by users. AVS currently sold about $2 million in this
market, a four percent market share. The AVS management thought that it could substantially
increase the presence if AVS could offer an application that can be seamlessly integrated with
others already in use by end-users. One marketing manager was arguing for this engineering
vertical market by saying, “this is an opportunity to become a star in a niche market that is too
small for strong competitors to get in but good enough for a company like ours.”

Harry Cochran and the Future of AVS

Harry Cochran had been hired in early 1997 and was given broad latitude to engineer the
revival of AVS. He was a veteran entrepreneur in the software industry. Prior to joining AVS,
he had been chairman of TRUE Software, Inc. and founder, president, and CEO of Expressway
Technologies Corporation Technologies, a pioneer in interactive decision support systems.
Cochran had overseen Expressway’s growth from initial start-up to its ultimate sale to Sybase. At
Sybase, he served as vice president of Advanced Indexing Products before deciding that new
opportunities beckoned.

When he first arrived at AVS, Harry interviewed nearly all 105 employees in the
company and asked each of them to share their thoughts on what was right or wrong with the
company and where opportunities lay. He discovered a disillusioned group sailing what he
termed a “rudderless ship” with little pro-active decision-making, inter-divisional strife, and no

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dominant market position in any of the vertical markets in which AVS sold its products. Almost
everyone had been “burned” so often that they were pessimistic about the future of the company
and taking any sort of risk. The unspoken but prevalent corporate credo was “don’t lose” rather
than “win”.

Product development engineers felt burned because of lack of follow-through from the
sales and marketing team. From the perspective of the sales and marketing team, however, those
in product development were too focused on adding bells and whistles to existing software
without the benefit of any end-user input. They often were left frustrated in their efforts to sell
directly to large end-users or to developers who were trying to customize products to those end-
users. Indeed, AVS had been technology-driven to the point where the people in marketing and
sales were only brought in to figure out how to sell new products after they were completed.

Often development engineers were distracted from their work by requests for quality
assurance, to produce documentation, or to offer customer support. They thus avoided such
distractions whenever possible, often leaving these activities incomplete.

With increasing pressure to increase profitability and sales, everyone either retreated to
backbiting or discovered the security of monastic seclusion.

Harry did, however, find a number of strengths that offered the foundation for
opportunity. The balance sheet was healthy. AVS had over $7 million in cash, no debt, a history
of at least marginal profitability, a good reputation, and a core of good technicians. The company
had a large net operating loss carry-forward from Stardent that would, management thought,
provide shelter for a significant portion of future profits.

After then studying the dynamics of both the software industry and those of AVS’s
primary customers, Cochran was considering what changes might be required to bring AVS out
of the doldrums. He thought that AVS had been trapped in an outdated perception of the
marketplace. While the developer market was still strong and sophisticated users in specialized
laboratories still relied on AVS software, the market was essentially flat. He saw that the
increased usage of data visualization within the specialized vertical markets represented a viable
opportunity. AVS would never be able to compete in this market, however, if it just kept making
its existing software more complex, and, if less sophisticated users were courted, AVS would
have to develop its consulting and service capabilities to offer adequate support and
customization.

Cochran knew that he would have to answer several key questions before proceeding:
what vertical markets should be targeted and what resources would be required to realize the
opportunity of those markets? In addition, he wondered what changes should be made to the
current operations better to meet the needs of existing customers.

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Advanced Visual Systems, Inc. BAB001

Exhibit 1
Financial Statements

AVS Balance Sheet

1994 – 1996

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Advanced Visual Systems, Inc. BAB001

Exhibit 1 (Continued)
Financial Statements

AVS Income Statement

1994 – 1996

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Advanced Visual Systems, Inc. BAB001

Exhibit 1 (Continued)
Financial Statements

AVS Cash Flow Statement

1994 – 1996

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Advanced Visual Systems, Inc. BAB001

Exhi
bit 2
Revenue
Analysis
(x 1,000) Total US Europe Japan
1994 1995 1996 1994 1995 1996 1994 1995 1996 1994 1995 1996
Product
AVS5 6,272 4,777 3,575 2,795 1,939 1,247 3,167 2,334 1,692 310 504 636
Toolmaster 4,718 3,412 2,245 321 509 369 4,345 2,855 1,846 52 48 30
AVS/Express 366 3,103 3,956 326 1,942 2,557 40 1,113 1,251 48 148

Gsharp 805 804 21 49 760 705 24 50

VIS/Express 413 80 302 31
Total Product 11,356 12,097 10,993 3,442 4,411 4,302 7,552 7,062 5,796 362 624 895
Support
AVS5 1,831 2,410 2,089 1,272 1,287 939 559 1,123 1,122 28
Toolmaster 4,687 4,657 4,251 714 583 556 3,939 4,046 3,684 34 28 11
AVS/Express 21 234 751 20 151 488 1 83 262 1
Gsharp 128 5 122 1
VIS/Express 12 3 8 1
Total Support 6,539 7,301 7,231 2,006 2,021 1,991 4,499 5,252 5,198 34 28 42
Consulting 722 984 984 422 523 593 300 461 391
Other 358 882 249 81 202 6 277 680 171
Bundled Support -1,717 -1,857 -1,541 -510 -586 -501 -1,207 -1,271 -1,040
Total Revenue 17,258 19,407 17,916 5,441 6,571 6,391 11,421 12,184 10,516 396 652 937
Direct Expenses
Production 1,472 1,353 1,582
Consulting 350 799 745
Support 1,003 1,746 1,503
Contribution
Production 9,884 10,744 9,411
Consulting 372 185 239
Support 5,536 5,555 5,728
Contribution Margins
Production 87.0% 88.8% 85.6%
Consulting 51.5% 18.8% 24.3%
Support 84.7% 76.1% 79.2%
Product as % of Total 65.8% 62.3% 61.4% 63.3% 67.1% 67.3% 66.1% 58.0% 55.1% 91.4% 95.7% 95.5%
Support as % of Total 37.9% 37.6% 40.4% 36.9% 30.8% 31.2% 39.4% 43.1% 49.4% 8.6% 4.3% 4.5%
Support as % of Product
AVS5 29.2% 50.5% 58.4% 45.5% 66.4% 75.3% 17.7% 48.1% 66.3% 0.0% 0.0% 4.4%
Toolmaster 99.3% 136.5% 189.4% 222.4% 114.5% 150.7% 90.7% 141.7% 199.6% 65.4% 58.3% 36.7%
AVS/Express 5.7% 7.5% 19.0% 6.1% 7.8% 19.1% 2.5% 7.5% 20.9% 0.0% 0.7%
Gsharp 0.0% 15.9% 0.0% 10.2% 0.0% 17.3% 0.0% 2.0%
VIS/Express 2.9% 3.8% 2.6% 3.2%
End user sales $8,103 $7,992 $7,021 $4,067 $3,247 $2,323 $3,726 $4,217 $3,951 $310 $528 $747
Developer Sales $9,792 $11,406 $11,203 $1,381 $3,185 $3,970 $8,325 $8,097 $7,043 $86 $124 $190
Total Sales by Product
AVS5 $8,103 $7,187 $5,664 $4,067 $3,226 $2,186 $3,726 $3,457 $2,814 $310 $504 $664
Toolmaster $9,405 $8,069 $6,496 $1,035 $1,092 $925 $8,284 $6,901 $5,530 $86 $76 $41
AVS/Express $387 $3,337 $4,707 $346 $2,093 $3,045 $41 $1,196 $1,513 $0 $48 $149
Gsharp $0 $805 $932 $0 $21 $54 $0 $760 $827 $0 $24 $51
VIS/Express $0 $0 $425 $0 $0 $83 $0 $0 $310 $0 $0 $32

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