Leapfrog's Great Leap Forward

It took Wood another three years of working with Calfee and tech gurus from Sandia National Laboratories before he figured out a way to produce a $50 talking alphabet. But the big break didn't come until he demonstrated the device to a Toys "R" Us buyer, who said that he would purchase 40,000 if Wood could mass-produce it. That one single order gave Wood the validation that he needed to leave his law partners and embark on the perilous road of launching his own startup. LeapFrog was born, and its first product, the Phonics Desk, remained one of the company's best-sellers for years.

Wood's three years of working to build the Phonics Desk yielded something that has ultimately proved invaluable: the process that LeapFrog has used to develop every product it has ever marketed. "It's a five-step sequence," says Wood. "Understand the problem you want to help kids solve; ally with educational experts to figure out the best way to teach the concept; work with the best technology people to present the content in a way that's intuitive and engaging; meet with parents for a reality check; and get that buy in from retailers to ensure that you've got the demand before you commit to delivering the supply.

"If we don't get an A+ at every step of that process, we won't do the launch," Wood continues. "Not every A+ product succeeds in the marketplace, but you might as well start with the bar set as high as you can possibly get it. Because you'll never get A+ results out of a B+ product."

Money and a Mentor

Wood founded LeapFrog just as the dotcom fever was heating up. But the young Bay Area company was for the most part immune to the tech mania that swirled all around it, largely because LeapFrog's first round of funding came from Wood's family and friends. LeapFrog's original office was all of 1,000 square feet. Wood and three colleagues worked at desks that consisted of chunks of plywood plunked across sawhorses. Such frugality was to some degree self-imposed: By turning their backs on the VC money that was saturating so many high-tech startups, Wood and his team hoped to instill the discipline necessary to build a sustainable enterprise.

Then again, external forces exerted their own kind of discipline. At its core, LeapFrog is a technology company that competes in the consumer-goods market, which means that it couldn't take four years to develop product or to grow at all costs to grab market share. "We're in the business of putting products on store shelves, where either they sell or they don't sell. There's no halfway," says Wood. "You execute, and you get to do next year's plan. You fail, and next year's plan is irrelevant. At every turn, that fact forced us to focus on the bottom line."

In its first two years, LeapFrog rode the success of its Phonics Desk. Business Week crowned it one of the best-designed products of 1996. But LeapFrog was plagued by the kinds of mistakes that so often befall rookie companies. Lacking the clout to connect with a major manufacturer, Wood partnered with a minor leaguer that couldn't keep pace with demand, resulting in late shipments and a $200,000 shipping bill for catch-up deliveries. Then LeapFrog lost its account with Wal-Mart, the largest toy retailer in the United States.

"We placed the original Phonics Desk in Wal-Mart during our second year, and it had a remarkably good sell through," Wood recalls. "But then Wal-Mart decided that it didn't want to carry lots of product from just one company, and they dropped us. That showed we really didn't understand our retailers -- and we certainly didn't have a relationship with the senior managers who were formulating Wal-Mart's strategy. Losing Wal-Mart was a devastating blow." (Later, LeapFrog won Wal-Mart back. And in April, the company was named Wal-Mart's Vendor of the Year.)

The Wal-Mart debacle pushed Wood to look for an outside investor. On paper, the company was doing well. By 1997, it had seven products on the market. In three years, it had grown from $3.2 million in sales to nearly $18 million. But LeapFrog lacked the capital to implement its best ideas, and it was making too many mistakes. And so Wood sold a 65% stake in LeapFrog to Knowledge Universe for $50 million.

Knowledge Universe's marquee names might belong to Ellison and Milken, but for Wood, the deal's closer was the chance to enlist a man named Thomas Kalinske, the VC fund's president. Kalinske had been president and CEO of Mattel and Sega of America, two giants of the industry. He knew the leaders of virtually every major toy retailer in the country. And his marketing instincts were honed from more than 30 years of working in the field.