Little Niches That Grew

A combination of focus and expertise can mean big money from narrow markets

A decade ago, James McDonald was considered a dreamer when he predicted cable companies would soon offer digital movies on demand and push-button shopping from living rooms. Yet McDonald, chief executive of cable set-top box maker Scientific-Atlanta (SFA ), never gave up--even after his first interactive TV cable box flopped in a 1993 test in Orlando. The boxes cost $5,000 apiece to produce, and consumers weren't clamoring for their I-TV. "The cable operators were about to give up on us," McDonald admits.

Last year, McDonald's foresight and patience finally paid off. Cable providers were desperate to fend off competition from satellite systems like DirecTV. Meanwhile, Scientific-Atlanta had fine-tuned its digital box, packing it with dozens of interactive features such as e-mail and e-commerce, and bringing the price down to $300. Today Scientific-Atlanta supplies 52 of the 100 largest cable-TV systems with digital boxes. In the most recent quarter, the company's sales surged 51%, to $663.7 million, and earnings doubled, to $76.2 million.

Scientific-Atlanta--No. 3 on BusinessWeek's Info Tech 100--is one of a dozen or so midsize companies on the list that struck gold by conquering a niche market. Other standouts: No. 4 Nvidia Corp. (NVDA ) is tops in the market for graphics chips that create the realistic special effects video gamers love. And Check Point Software Technologies Ltd. (CKP ), No. 10, dominates the market for so-called firewall software that protects Web sites from intruders.

These companies were far from overnight sensations. Rather than pursue the false promise of instant e-commerce riches, they quietly plugged along for years, nurturing market segments that could continue to grow even in an Internet downturn. Now niche players are bubbling to the top with polished products and workable business plans that can weather the storm.

FOCUS FIRST. How do the best niche players do it? It pays to spot a market first. Successful niche players must also constantly out-innovate the competition as giant companies start to move in on them. The smart ones form relationships with strategic partners that can complement their core abilities. And most importantly, they keep their focus, even as they grow rapidly. "We're not going to di-worse-ify," says David E. Maguire, CEO of Kemet Electronics Corp. (KEM ), No. 38 on our list. Its sales grew 71% last year, to $1.4 billion, as the company sold billions of one thing--the tiny capacitors that control the flow of electricity in everything from cell phones to rocket ships.

Often, when a new market is emerging, a lot of people notice it. So the smart thing is to figure out what's going to be the valuable piece of the business over the long haul. That's what Brocade Communications Systems (BRCD ) did two years ago when it entered the now fast-growing field for so-called "storage networks"--systems that link multiple storage devices. Rivals built storage "hubs," which steer data between computers and preselected storage machines. Brocade created a new kind of "switch," which can intelligently determine the best place for each chunk of data to be stored. Brocade chose right. It's No. 59 on our list, with sales nearly doubling, to $115.2 million, last quarter. "To the intellectually lazy, hubs were the obvious thing. We tried to take a longer view," says Brocade CEO Greg Reyes.

STRENGTH MOVES. The trick for niche players is figuring out when and how to expand. When the niche champs size up potential new markets, they look for conditions that play to their strengths. Once Nvidia had mastered the art of creating graphics chips for PCs, it built on the same core technology to create chips for the laptop and workstation markets. Then the company expanded into making graphics chips for video-game consoles, scoring a contract for Microsoft Corp.'s (MSFT ) upcoming Xbox. Revenues surged 62% in the most recent quarter, to $240.9 million.

Not all adjacent markets that seem promising pan out. Analog Devices Inc. (ADI ), No. 44 on our list, a specialist in chips for handling audio and video communications, branched into chips for the disk-drive business about eight years ago. It soon discovered that the pricing pressures were too intense to yield the profit margins it had come to expect. The company bailed four years later.

Another pitfall: trying to pack too much into a product. Nvidia's first chip, introduced in 1995, was more than a year late and jammed with so many extraneous features that it didn't perform well. The company started over, focusing on providing the two-dimensional and three-dimensional graphics that designers and gamers crave. The lesson: "Do fewer things really well, focus, and don't try to take on the world," says Nvidia CEO Jen-Hsun Huang. With the right game plan, small fry can make it big after all.

By Arlene Weintraub in Los Angeles, with Charles Haddad in Atlanta, Cliff Edwards in San Mateo, Calif., and Geoff Smith in Boston

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