Acquisition Fever

Mention the word "franchising" around DuPont Flooring Systems these days and you could get an earful - on how to go about starting a franchise system the right way. Phrases like "mutual capabilities," "dedicated channel of distribution," and "delivering value to the franchisee and customer" are part and parcel of the approach that DuPont management took to its entrance into franchising. Add to that the acquisition of the prototype operation - an established independent flooring business with locations in 47 cities - to serve as the basis for operating systems and management processes, and the inherent challenges and opportunities of melding two dramatically different corporate cultures, and you have a primer on how one of the world's largest companies chose to enter franchising.

DuPont is just one of hundreds of traditionally structured companies that have turned to franchising as a method of guaranteeing a future channel of distribution for their products. The movement to include merger and acquisition as a strategy to develop and expand franchise systems has reached almost epidemic proportions in recent years, and it doed not appear that there will be any slowdown.

Pick up any newspaper and chances are you will find something on acquisition or merger within the franchising industry. In November, HFS Inc., the hospitality, real estate and travel service giant, announced its most recent acquisition, Jackson Hewitt, the second largest tax preparation franchisor, for $483 million dollars. HFS has steadily grown through strategic acquisitions of brand name companies such as Coldwell Banker, Century 21, Avis, Days Inn, and Howard Johnson. Their strategy of growth through acquisition will continue with their upcoming merger with CUC International, a company that offers travel and shoppers' club memberships and coupon books.

In October, The Franchise Company of Toronto, a franchisor of property and business services, acquired Paul Davis Systems, an industry leader in the area of insurance restoration. Earlier in the year they had added Stained Glass Overlay to its cluster of brand named franchise programs. Service Master Inc.'s Merry Maid, Orkin Pest Control, Terminex, Chem Lawn, and Furniture Medic show the common thread in much of today's acquisitions. As with HFS, an overview reveals management's goal of targeting companies that form a strong network because of the symmetry between their customer bases. In June, Consolidated Vision Group, Inc., acquired Texas State Optical, a network of 112 primarily franchised locations based in Beaumont, Texas.

Acquisitions in the food industry have been numerous. CKE has brought together under common ownership Hardees, Checkers Drive In, and Rally's. Wendy's recently acquired the Canadian-based donut chain Tim Hortons; AFC, parent company of Churchs and Popeye's, added Chesapeake Bagel to their stable of franchise systems. In late fall, Blimpie's, the second largest franchisor in the submarine-sandwich niche, decided to buy Maui Tacos, a Hawaiian-style Mexican food chain. Even troubled Boston Market, faced with declining unit sales and operational issues in their core operations, made acquisitions of two bagel concepts, Einstein and Noah, and continues to look at other acquisitions.

Each acquisition shared a common theme of a broadened customer base, market penetration, and with some the extension into new or the strengthening of existing day parts or improved real-estate utilization. As systems come under common ownership, there is often significant savings in shared costs including field services, real estate, professional costs, marketing, etc.

Acquisition fever is running high - and with good reason. While domestic markets continue to shrink as a growth opportunity for some brands, companies are eyeing other established channels of distribution as a way of achieving a dedicated route to market or to better utilize their established infrastructure. "Under these conditions, teaming up makes sense if it is done for the right reasons and the underling methodology is sound," says Craig Corey, vice president of DuPont Flooring Systems. "We wanted to make sure we had the capability to adequately operate a flooring contractor business before we started to ask people to pay us money to be part of the network we wanted to create. We also wanted to be able to deliver the value to those same people and, through them, to their customers."

DuPont's program combines one of the most valuable brand names in corporate history with product and installation technology, carpet maintenance and chemistry, as well as a recycling program that guarantees that carpet removed from commercial structures will not add to the landfill problem in the United States. (DuPont is now remanufacturing recycled carpet into pellets that ultimately become part of that Ford you are driving).

Mutual benefit - long the cornerstone of successful franchise relationships - stands behind why franchisors acquire other companies. Anthony Conza, founder and CEO of Blimpie's, admits that he is hoping the newly acquired Maui Tacos will improve system performance and profits by capitalizing on this country's increasing preference for Mexican foods. Conza wants to take advantage of Blimpie's franchise infrastructure to introduce new products - and profit centers - to his market segment.

Steve Rogers, president of The Franchise Company, looks for acquisition candidates that are well managed, profitable, and growth oriented. In return, he says, "we offer the management of our franchise systems a vested equity interest."

Franchisors look for an added value element to the products or services offered by the incoming company. It makes sense for a consumer-based concept to bring together residential housekeeping, commercial cleaning, painting, carpet cleaning, vertical blinds, lawn care, pest control, or fire restoration. One set of services or products promotes the other as they provide cross-over access to common consumers.

For companies not involved in franchising, however, entering the "franchise business" may come with some significant barriers, including a strategic fit which is less than was anticipated or an effect on the core operations which undermines the value of the existing operations.

When DuPont Nylon decided several years ago to establish a dedicated downstream route to market for their commercial fiber, part of their strategy was to acquire several small, well-established commercial flooring companies. Each of the companies offered DuPont strengths in a specific area such as service philosophy, efficiency standards, management and sales expertise, and operational and bottom-line excellence. Their latest acquisition, MSA Industries, the largest independent flooring contractor in the country, was in the midst of establishing a network of 47 company-owned locations in key cities.

"MSA had people in-house who had the capabilities of rolling out a national network," says Corey, "and we wanted that expertise to be part of our franchise development efforts." Using an established independent company as a franchise prototype offers a lot of pluses: DuPont gains instant credibility in the marketplace; resources are leveraged more effectively; new programs are developed; the DuPont brand is strengthened; each dealer, already an industry leader, gains significantly through a national network; and the franchised company's position in the marketplace is all but guaranteed.

The benefits of joining with a strong industry leader can often be numerous. New technologies and product extensions become available to franchisees; stronger marketing and greater market reach can often be achieved. Often, the experienced and well-capitalized acquirer can reduce the franchisee's unit operating costs as the expanded buying capacity of the combined systems strip costs from each of their operations.

For example, for the new DuPont franchisees, whose existing business sales were already measured in the multi-millions, they can now offer their customers the ability to lease their carpet and flooring products. This financing ability gives the franchisees an enormous advantage over independent operations in the sale of flooring products to hotels, building management companies, and other large users of flooring products. These same franchisees can also provide their customers with certificates, backed by DuPont, which relieve them of any environmental liabilities that can arise from the placement of their old carpet into landfills. They also benefit from the extensive DuPont buying power for financing, insurance, computers, vehicles, telephone services, office equipment, etc.

Precautions taken at the beginning of the process can mitigate misunderstandings later on. All parties need to understand the benefits and pitfalls of the new alignment. Most industry experts, experienced in franchise system mergers and acquisitions, recommend that any issues which exist between the franchisee and their existing franchisor be surfaced early during the due diligence process. The ideal is that solutions at this stage will only strengthen the new management-franchisee relationship, thus benefiting all parties. Consider this an appropriate period of time to clean the old relationship and strengthen the future.

For companies interested in acquiring a franchise system, there are a few words of cautious advice:

  • Consider the strategic fit and the downstream consequences. Determine where the company is positioned in the marketplace and the effect the acquisition will have on the acquiring company's core business, including established distribution channels. Ascertain the advantages of the combined real estate (which is often one of the principal reasons for the acquisition, as quality space becomes dearer). Look at the ability to leverage the combined customer base. Such strategic fits are smart buys.

  • Consider the management you are acquiring. Look at their depth of experience and their track record in managing the business. If they are not currently in franchising, the skills of franchising can either be taught or inserted, but it is the core competency of management which often makes up much of the value you are acquiring. Be sensitive that luck most often happens only once, and being in the right place at the right time is rarely an indication of sustainable genius. Make certain they understand what industry they are in, have been able to solve the problems they have had, and have continually grown their enterprise.

  • Consider the corporate cultures and the underlying relationships. If you are buying an existing franchise system, much of the asset valuation is not in the traditional "bricks and mortar" but in the "off balance sheet" assets. Franchise system valuation is based upon purchasing the relationship that is underlying the continuity of the future cash flows. Are those relationships sustainable? Will the franchisees renew their agreements? Do the franchise agreements have past or future liabilities, restrictions, or conflicts that make the marriage problematic?

A final note: When acquiring a franchise system, the single biggest mistake you can make is to think you are in the franchise business. You aren't. You are acquiring a business within an industry, which means that you must understand how the underlying business stacks up against the competition, whether franchised or not. And, as DuPont's Corey says, "You have to be in a position to deliver value - value to the consumer and value to the people you want as your franchisees. If you think you're going to wring money out of the acquired franchise, you're heading in the wrong direction." Securing a dedicated route to the marketplace while ensuring the success of all those involved is the bright spot offered through properly executed acquisitions.

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