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Robert Kierlin Fastenal Inc. Winona, Minn

Building the U.S.’s Largest Fastener Company

This profile is excerpted from Bootstrap to Billions: Proven Rules from Entrepreneurs who Built Great Companies from Scratch by Dr. Dileep Rao. Copying or reproduction in any format or medium without the prior express, written consent of the author is strictly prohibited. For additional profiles or information: InterFinance Corp. Phone: 763-588-6067; www.uEntrepreneurs.com; www.infinancing. com

The company: In 1967, when Bob Kierlin started Fastenal in Winona (Minn.), it was the smallest of 10,000 fastener (such as nuts and bolts) businesses in the United States. By 1997, it had become the largest. The company became profitable by 1969, reached $100 million in annual sales by 1993 and $1 billion in sales by 2004. Kierlin was the chief executive from startup and still remains chairman. The only equity raised, prior to the initial public offering, was $22,000 at startup from Kierlin and three Winona friends, and an additional $9,000 a year later from a fifth investor who was a friend. From this start, Kierlin has built a company that has a market cap in excess of $5 billion. This is how he did it.

From Startup to Profits

1. Vision at startup. After finishing his MBA, Kierlin spent two years in the Peace Corps and then started to work for IBM. But his dream since high school was to develop a vending machine to sell nuts and bolts. So in 1967, he and three friends raised $22,000 and developed a vending machine to sell fasteners. This vision, which was gestating for many years, produced a product that lasted only a few months. The quantities and sizes demanded by customers were different from the ones in the machine. Kierlin listened to his customers and scrapped the vending-machine strategy. He continued the business in a 1,000 SF store, and hired a store manager while he continued to work at IBM.

Lesson: Be flexible and humble. When your initial idea does not work (as it often doesn’t in new ventures), talk to your customers and adapt to what the market demands.

2. Strategy for growth. The first store had sales of $18,000 in the first year and was showing promise. So Kierlin started looking for expansion opportunities. Since he was working for IBM in Rochester, he bought a contractor supply house there. This was a mistake. The business had been for sale for about six months, and the good inventory had been sold. What was left was dead stock. This was the last business purchased by the company. All future expansions would be internal.

Lesson: Growth via acquisitions can be a risky strategy especially if you don’t know how to buy a business, including its valuation, pricing and financing.

3. Right time to jump in full time. By 1973, the business had grown to $255,000 in sales

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from three stores. Kierlin decided that the time had come to leave IBM and jump full time into the business. Joining the business meant that he no longer had his IBM salary, and Fastenal had to generate the cash flow to pay him. So he had to be sure that the business could be expanded to pay for the increased overhead.

Lesson: Lay the groundwork, if you can, before you have to leave your corporate job. This way you may not have to seek venture capital when you are ready to jump in.

4. Riding the trends. Prior to the 1960s, fasteners were made by the large integrated steel companies. They saw fasteners as an imposition, something they had to make to sell steel beams, which was their primary product. Their service and pricing were poor. So some fastener buyers persuaded Japanese companies to make fasteners. Fastenal took advantage of the lower prices offered by importers of these fasteners. Its average gross margin grew from 34% to 50%, and this fueled faster growth.

Lesson: Understand trends, study the big picture and take advantage of new situations, including better prices and margins.

5. Expanding with flexibility. Initially Fastenal only had 1,000 SF of space. But to take advantage of the lower Japanese prices, Fastenal needed to buy inventory in bulk. This meant that the company needed storage space. So the company started renting nearly all the available garage space in Winona on short-term leases. The company kept track of the inventory on 3”x5” cards. When a new store opened up and needed inventory, all Kierlin had to do was go around to the garages and ship the inventory to the new store.

Lesson: Be flexible and find the most cost-effective way to solve your problem.

From Profits to the Moon

6. Connecting with the industry. Kierlin’s goal was to make Fastenal into the leader of the fastener industry. Since Kierlin and his key team had learned the business themselves, and since they had not gained much from the industry, they did not see the need to share what they had learned with the rest of the industry. They decided that the best strategy for them was to continuously improve on their own, and to rely on their employees for their competitive advantage and industry dominance.

Lesson: When you are ahead of the industry, others will pick your brains to gain advantage at your expense. Don’t boast about what you have learned.

7. Buy or make. Fastenal wanted to make sure that it could serve the fastener needs of all its customers. To do this, it had to be able to sell the standard items with fast turnaround times (which means Fastenal needed inventory), and at competitive prices. The company also had to offer customized fasteners when customers needed them. However, the small machine shops that made these special fasteners did not have the same sense of urgency or reliability as Fastenal. In some cases, they had not even started manufacturing them by the promised date. So Kierlin decided to manufacture these specialized fasteners internally. This allowed the company to better serve its customers and improve its competitive advantage.

Lesson: Understand why customers are buying (or will buy) from you and serve them on time and without excuses. Be able to control the level of service you offer.

8. Treating employees with respect. Fastenal gave wide latitude to its employees. Store managers picked their inventory, developed their customers, and were judged on results. Machine

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operators selected their jobs. Open jobs were color-coded in groups by order of delivery date and placed on a board where all the operators could see them. Machine operators who finished a job picked their next job from the highest-priority group without interference from supervisors and the central scheduling department. This gave employees a variety of jobs, minimized boredom and allowed them to maximize their potential.

Lesson: Cut overhead and allow your employees to make decisions they are capable of making within the larger framework, and they will appreciate it. Treat employees as if they had other job offers. In any type of market, the best ones will have options.

9. Serving customers. One Friday, a Fastenal manufacturing estimator got a call from his store manager in Indiana. A Ford plant had lost one of its main mixing machines due to a broken part. The machine was made in Europe and used the metric system, and it would be about a week before a replacement part could be obtained from Europe. Could Fastenal make the part any sooner? The estimator found some blanks in Ohio and had Northwest Airlines fly them into La Crosse, Wis., where Fastenal picked them up. The company then machined the fasteners on Friday night, had them heat treated on Saturday and asked the Winona Flying Club to fly them back to Ford. The part was at Ford’s plant on Sunday morning, installed by Sunday night and the machine was ready for the Monday-morning shift. Fastenal’s cost was $1,700, and Kierlin felt uneasy that Fastenal charged Ford $7,000. But that was only until he received a thank you letter from a Ford executive saying that Fastenal’s timely actions had saved Ford about $400,000.

Lesson: Make customers your top priority. Go beyond “reasonable” service, and you will differentiate yourself from your customers.

10. Finding new products. Kierlin found that he was getting ideas for new products from branch managers, and he attributes this as one of the key reasons for the success of Fastenal. Early on, when he expanded into his third store, a local contractor told him that his own performance suffered when he had three houses under construction since he could not be at all three places. Kierlin decided to decentralize decision-making. He found good people, trained them in the company culture and beliefs, set some basic rules of conduct, treated them fairly and challenged them to achieve their potential. Many companies and executives talk about this but don’t always develop a structure that does this with trust. Except for quality-control manuals, the other manuals are very thin. Store managers can make their own decisions on ordering, buying, selling and pricing. They are rewarded on their store profitability and return on assets. With each store manager innovating to meet customer needs, the company got many practical and innovative ideas that worked in the field rather than based on business-school marketing theoreticians. To this day, managers only receive about two-thirds of their products from central purchasing. The rest of their purchases are from sources developed by the managers themselves. However, to control “irrational exuberance” in new managers, all large custom-inventory purchases have to be approved by district managers and backed up by dated purchase orders.

Lesson: Find good employees. Give them good training and tell them your expectations. Give them the freedom and challenge them to find their potential. Keep the rules simple. Delegate and reward based on results. But have basic rules to control risk.

11. Minimizing hierarchy. Everyone pitched in when needed. When the company moved its headquarters to a new building in Winona, all the employees including the CEO moved the furniture, fixtures and files over a weekend. Senior managers who held class C drivers licenses drove the trucks, since some of their truck drivers had driven over their quota for the week.

Lesson: Don’t show off. Don’t act superior. Share the load.

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12. Opening communications. Fastenal has a policy that anyone can call to talk to anyone else at any time. They do not have to get permission before doing so. Kierlin found that this open- line communication system develops a culture of trust and openness. Open communications went both ways. Every morning starting at 7 A.M., Kierlin would check the sales of the stores for the previous day. Each store that had sales in excess of $5,000 got a phone call from Kierlin and he would congratulate whoever picked up the phone. Many of them were surprised to hear from the CEO, but this spurred them to better performance.

Lesson: Develop “chaotic” communications rather than “silo” communications if you want your co-workers to feel valued. And let them know you appreciate good performance. Money is important as a motivator. Recognition may be equally key.

13. Upgrading and retaining. All of Fastenal’s managers are promoted from within, except for its legal staff (for some reason, lawyers don’t seem to want to become store-manager trainees). All the officers started as trainees, and the HR director (who is also on the board of directors) started as a receptionist. This created a deep sense of loyalty. To make sure that new and promoted employees live up to their potential, Fastenal started the Fastenal School of Business in Winona to train them (instead of renting hotel rooms, Fastenal bought and maintained an apartment building to reduce costs and improve their employees’ stay). To motivate sales employees, Kierlin developed a pay package where the base salary is less than half of the total potential. The balance is based on performance, including store profitability and return on assets.

Lesson: Train your employees and treat them well. Be fair. Believe in your people and give them a chance. Offer incentives in their pay package that motivate them.

14. Sharing the wealth. Kierlin could pick the right time to go public because he had patient investors. This happened in 1987 when the company had 52 stores and $20 million in annual sales. In addition to liquidity for key shareholders, Kierlin also wanted to offer employees an opportunity to share in the company’s growth. Therefore, in the IPO, 10% of the 1,000,000 shares (at $9) were reserved for employees. Some enterprising employees went around and acquired shares allotted to others who were not interested in buying the shares, and became wealthy.

Lesson: Allow your employees to share in the dream.

15. Controlling expenses. Fastenal always believed that executives and employees needed to be frugal when spending corporate money. This applied to all, starting from the top. When they traveled, they were expected to find the most reasonable rooms and means of transportation. Kierlin himself followed this rule, including staying at low-cost motels. He believed in leading by example, not by edict. When buying trucks, Fastenal found that buying used trucks was not wise, since they tended to break down. So Fastenal bought new trucks in large quantities and sold them at retail after using them for a year for practically the same price they paid for the new trucks. This idea came from the field.

Lesson: Don’t expect your employees to be frugal if you are not. If your employees come up with an innovative plan that works, implement it and recognize them.

16. Develop your company’s key metrics to grow with control. Early on, Kierlin found out that the company could grow without external financing if he stuck to certain metrics. For growth, Fastenal needed to fund inventory and receivables for new stores. They found that there was a relationship between inventory turns, gross margins and growth. When gross margins were 50%, and inventory turned over three times annually, the company could grow at an annual rate of 30%

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without external financing. So each year, they would calculate the average number of stores in the past year, and increase the number of stores by 30%. For any product that had three turns, they expected minimum margins of 50%. For two turns, the margins had to be at least 60% and with 40% margins, they needed four turns. At 30%, they did not stock the inventory but bought it from the manufacturer for direct ship to the customer. The company also set up its management training and growth plans for 30% growth. This meant that they needed to have enough experienced managers who were ready for the new stores, and trained store assistants who could take over the existing stores. One year, Kierlin got enthusiastic and suggested growth of 40%. His managers became even more enthusiastic and tried to get 50%. Chaos ensued. There were insufficient trained store managers, cash flow became tight and customer service deteriorated. Kierlin resolved never to do that again.

Lesson: Know your company, your people, your products and the financial metrics. Ultimately, all roads lead to Rome, i.e., to the financial results. When making changes, make sure you test the impact of the changes on a small scale before engulfing the entire company in potential chaos.

17. Listening to Wall Street analysts. After Fastenal went public, investment analysts constantly questioned Kierlin as to whether Fastenal needed new, experienced leadership to take the company to the next level. One benefit of owning a huge chunk of stock, and not having venture capitalists with even bigger chunks, is that you don’t always have to listen to the analysts. Kierlin did not. All he did was reward his stockholders with one of the best performances of any publicly traded stock. A 1996 study of initial public offerings for the previous decade showed that Fastenal ranked second among the best performers. Only Microsoft ranked higher. One dollar invested in Fastenal at the IPO was worth $59 in 1996.

Lesson: Wall Street analysts are not always right even if they call themselves “smart money”.

Rules for Entrepreneurs from Bob Kierlin of Fastenal

• Pursue a common goal and bring out the potential of all employees toward the goal. Challenge your managers rather than controlling them, and give them the freedom (with some basic financial restrictions) and training to help them reach their potential.

• Listen more. Speak less. Build open communications that allow anyone to directly call anyone in the organization without supervisor permission to discuss a company problem.

• Hire employees who practice empathy. According to Kierlin, employees who are likely to leave their carts in the middle of the grocery-store aisle don’t have empathy, or even awareness of other people. Train employees to be aware of how little they know rather than how much they know.

• Reward achievement. Employees will work to their full potential if given the chance and if rewarded when working toward a common goal.

• Build the culture you want. Develop a great company with extraordinary people who can continue on the path toward greatness even after you have stepped down.