Follow up to Franchisor as Exlusive Supplier (Krispy Kreme case)

More on the Krispy Kreme and Franchisee lawsuit:

Court documents filed in the case paint a cloudy financial picture for Sweet Traditions. In an affidavit, Sigurdson said a "continued catastrophic decline" in sales contributed to net losses of $1.2 million in 2003 and $3.2 million in 2004 and an operating loss of $2.2 million so far this year for Sweet Traditions.

He blamed Krispy Kreme for pressuring the franchise to expand too quickly, for overcharging it on supplies and equipment and for failing to promote the brand, even though Sweet Traditions has paid $2.5 million into a "brand fund."

As a follow up to the previous post Is caring for the elderly a profitable business?, I’ve been looking at a few other elderly care franchises.  My preliminary favorite is Comfort Keepers. All the non-medical elderly care franchises have roughly a $25K franchise fee and 5% royalties. But, Comfort Keepers sets itself apart with its strong brand recognition, blanket coverage of the United States and internationally, and smart online marketing. Why not buy into a system with the largest network of referrals and strongest brand recognition?  With social and demographic trending in a favorable direction, and heavy referrals from its web site, and barring any show stoppers from their franchise agreement, I’d lean towards buying it.

I was surprised to learn from this article that Quiznos pays commissions to its Florida outside real estate firm, Kotis Properties, to sign up franchisees. Possible conflict of interest?

In addition to helping find sites, Kotis Properties will also be helping Quiznos sign up new franchisees.

It seems this sales practice, along with high pressure seminars, is becoming more common in the franchise industry.

What can go wrong if your franchisor is also your supplier? A lot. Krispy Kreme, along with many franchisees such as Dippin’ Dots, are required to buy supplies direcly from the company. So what’s the big deal, right? Well, what do you do if they threaten to not ship supplies unless you agree to new terms, such as payment upfront instead of the normal 30-35 days? If you don’t comply you can’t operate your business. That was the unfortunate situation faced by a few Krispy Kreme franchisees. Krispy Kreme threatened to stop shipments unless it received $1 million that is in dispute (it didn’t say if those were late payments or due to new Agreement terms sought by Krispy Kream). In this case, the franchisees were lucky and the court agreed with their argument. The court ordered Krispy Kreme to resume shipment of supplies under the traditional terms of the agreement. The order includes assertions by the franchisee that Krispy Kreme –

"has refused to ship Plaintiff ingredients, supplies, and equipment, including doughnut mix – all of which are necessary to Plaintiff’s business operations – on terms previously agreed to by the parties."

Developing a high margin specialty niche in a stagnant industry is usually a formula for success (see Panera Bread’s twist on fast food, Sports Clips and Snip Its on hair cutting, Starbucks on coffee, Applebee’s on chain restaurants). Foot Solutions is a new shoe retailer looking to capitalize customers who require more comfortable foot wear, namely sufferers of diabetes, obesity and arthritis.

Concerns
Foot Solution’s web site details the anticipated $200,000 investment to open a store. The company expects the franchisee to sink $65,000 in shoe inventory before opening, yikes!

Foot Solutions requires you use only their vendors and approved products. And you must use their supply division to order opening orders, construction materials, fixtures and equipment. Of course, you should now be asking yourself, “How much more will I be paying if I was permitted to source the products myself?” Be sure to benchmark the average vendor and supply mark-up by asking the franchisor or franchisees for the actual price sheets.

Part of the reason to buy a franchise is the ability to buy into an already strong brand name. It is unlikely that customers are already familiar with the Foot Solutions brand (though it is a descriptive trademark, so intuitively people will generally understand the business’s purpose). There is also the dynamic of how many Foot Solutions can a local market support. Is it one, three, five? Niche franchises are much more susceptible to competition so the protected territory is an important issue.

There is a heightened liability risk. Franchisees receive training in foot pathology and physiology along with understanding the feet and related problems and symptoms. What if your sales person recommends a shoe that worsens a customers foot problem, or a customer relies on what they believe is your superior medical advice? Make sure you have high liability insurance coverage.

On the brights side…
From their FAQ:

Is this business profitable?

We cannot tell you how much you will make. Each store’s profit will depend on a number of factors such as total sales, monthly rent, labor cost, etc. We can tell you that most of the products you will be offering have an approximate cost of 40%, based upon our suggested selling prices.

The population trends favor this sort of business – obesity, diabetes and number of seniors are increasing. Local doctors can help generate a steady flow of referral customers. The customers are usually require special shoes and are willing to pay the hefty premium, with an average sale is expected to be about $200.

Conclusion
This is the sort of play that can work and be sustainable through referrals from customers and doctors. The margins are high and one or two trained staff can mind the store. I’d tentatively buy it!

Update 7-9-2005: Here is another article that includes pictures of their digital foot scanning machine.

Franchisee’s can sometimes successfully challenge and win in arbitration and court battles with their franchisors.

Subway’s founder Fred DeLuca lost his appeal to overturn an arbitration board’s decision that awarded Rottinghaus and Dowell, two midwestern Subway franchisees, $150,000 each. In 1997, DeLuca apparently didn’t want the two franchisees to be elected to the board of the Subway Franchise Advertising Fund, which distributes advertising money to Subway stores across the country. In 2001, the arbitration panel concluded that DeLuca violated Connecticut’s Unfair Trade Practices Act by pressuring the board to cancel the election and resolve new rules that prevented the two men from running.

It only took 8 years for this grievance to reach a final conclusion 😉

New smoothie franchises seem to be opening as fast as Starbucks and now Chipotle’s. Unlike coffee, a “smoothie” is not a staple of the American palate and never will be. Nonetheless, the smoothie business has been hot lately with the likes of Jamba Juice (who reinvented the market), Smoothie King, Maui Wowi, and Planet Smoothie dominating the marketplace. They’ve been riding the omnipresent “health” wave by using tasty fruits and vegetables and vitamin powders in their potions. But how long will smoothies be perceived as healthy? You should be asking that question if you are thinking of buying a smoothie franchise.

Just as financial markets always returning to the equilibrium, so do businesses. Eventually the product will commoditize, the market will saturate, and prices will drop (See the sub sandwich market).
The process can be accelerated by negative news, just as the low carb movement (which I followed for a while) subsided.

For example, if the national spotlight continues to highlight the high calorie count of smoothies defeating the impression of a healthy alternative to fast food, same store sales will suffer leaving smoothie franchisees with a lot of silent blenders. It’s already happening in the United Kingdom.

Mississippi’s The Sun Herald reports:

Thinking of ordering a smoothie for a healthful light snack between meals? Although these sweet fruity treats can be low in fat and rich in vitamins and nutrients, such as calcium and vitamin C, they can have a lot of sugar and calories. For example, a medium-sized Citrus Squeeze from smoothie chain Jamba Juice packs about five times as much sugar (103 grams) as a regular-sized Hershey’s milk chocolate bar (22 grams). It has 470 calories – more than a McDonald’s double cheeseburger (460 calories). Instead, try a lower-calorie smoothie option like of one of Jamba’s “Enlightened” smoothies.

The Wall Street Journal has an interesting article profiling an in-home elderly care franchisee.

Home Instead and the other senior-care franchisees pay caregivers somewhere between $8 and $12 an hour and charge clients about twice that amount. In the highly competitive Chicago market, the Melingers charge clients $18 an hour, with a minimum of two or three hours a day, or $180 a day for 24-hour care. They also provide a “rise and shine” or “tuck in” service, for $200 to $280 a week.

The Melingers declined to reveal just how lucrative their business is, but FranchiseHelp, a consulting firm in Elmsford, N.Y., provides some guidelines for similar businesses. In 2002, for example, a franchisee of Homewatch Caregivers in Denver, with 60 workers, took in gross revenues of $1,265,324 and paid out $1,141,578 in expenses that included royalties and the franchisee’s salary, leaving a profit of $123,746.

Their isn’t inventory to deal with, which is very nice. But that time is otherwise spent on finding and hiring responsible people they trust enough to send into an elderly person’s home. The franchisee said almost 1/2 the people don’t even show up for the their interviews and many quit after a few days. Ugh!

If you can maintain a steady staff, you can easily open a 2nd conierge style business, which we discussed perviously.

I’m neutral on elderly care franchises right now because they are heavily commonditized business (the market controls the fee level, it’s hard to charge more than $18/hr with all the competition). I am also hesitant when so much depends on finding qualified low wage employees that must work independently (unlike a retail location where managers can monitor what you do).

A few months ago we reported that Lenny’s signed a deal to open 125 Lenny’s Sub Shops in South Florida. Now the company is working on 80 franchise restaurantsin Texas.

The 80 new stores will be developed in Texas’ Fort Bend, Harris and Montgomery counties.

Len Moore (the “Lenny’s” in “Lenny’s Subs”) and his wife Sheila opened the first Lenny’s Sub Shop in Bartlett in 1998. Since then the company has spread like wildfire, making the move to franchising in 2001. The company currently has 63 franchise restaurants, with more than 300 franchises in nine states on the way, hoping for 500 by 2008.

What were you doing in 1998? Going from 0 to 300 franchises in 4 years is quite an accomplishment. How many more sub franchises can the market handle? The founder has extensive franchise restaurant industry experience. He held management positions with a number of companies including Chick-Fil-A, TGI Friday’s, Olive Garden and Ruby Tuesday’s.

We’ve mentioned Lenny’s on Franchise Pundit a few times before.

According to this 10-Q filed with the SEC by Papa John’s, average franchised store sales are 705k annually.

Papa John’s franchisees did increase sales 3.9% last quarter (Jan-March) compared to the same quarter last year.

Average weekly sales of franchised units: $13,563 ($705,276 annually)
Average weekly sales of company-owned: $15,075 ($783,900 annually)
* Why are the company owned stores outperforming franchisees by 11.15%?

The 10-Q speaks of one franchisee who sold his 19 restaurants with total annual revenues approximating $12.0 million ($631,578 per store) to a 3rd party. The restaurant sales were lower than the average by 11% or $70K, enough to obtain a loan writeoff from Papa John’s.

This isn’t good:

Domestic commissary sales increased 6.7% to $100.9 million for the first quarter of 2005, from $94.5 million in the comparable period, primarily due to higher cheese prices that were partially offset by lower volumes resulting from decreased restaurant transactions.

and this:

the first quarter 2004 operating margin was negatively impacted by the increased sales of lower margin promotional products

and this:

One group of 4 franchisees owning 33 franchises generated a $25,000 loss on $5.2 million of revenue, $4.6 million in operating expenses and other expenses (including G&A, depreciation and interest) totaling $600,000. Papa John’s also provided them with a large loan.

I do love their garlic dipping sauce for the crust that is included with each pizza!

Update 6-18-2005: Thanks to “Accountant” who in the comments pointed out my miscalculations. The post has been updated, including the title.

Update 6-19-2005: Thanks to “Ken King” who in the comments pointed out another miscalculation on my part. The post has been updated.

Should you buy a franchise, or start your own business? After reading this you may not be so scared to start your own.

Let’s assume you have decided to start your own "coffee and sandwich cafe" instead of buying a franchise. The franchise fee would have carried a $30,000 and a 7% royalty on gross sales. Here is one way to proceed with your business and fee savings:

1. Take the $30,000 franchise fee and invest $25,000 in the market or real estate. With compound interest of 11% over 20 years, you’ll have over $201,000 nestegg to retire on. Take the other $5,000 and hire a franchise or business consultant to help you build out and set up operations.
2. Let’s assume you’ll spend the equal amount on advertising as you would have with the franchise, say 4% of sales. Assuming your sales are $400,000, that is $1,333 a month on advertising. How about you spend that plus an additional $2,333 ($3,666 total) on local promotions and media buys to build your own brand awareness? You can with 7% or $2,333 royalty you’ll be saving. That can go a long way considering radio spots and many TV spots can be had for less than $100 per spot. Many small businesses would salivate to have a $3,600 advertising budget each month.
3. By cutting out the premiums you pay to the franchisor for supplies and food, you can spend that money on an extra employee to help during high traffic hours or on creative consultants to help with advertising and promotions. In other words, you can invest that money in building a customer base.
4. Take the franchise fee you must pay to renew your franchise every 10 years (some are only 5 years) and invest it in a consultant to help build your business further. Or, if you have been obtaining feedback and outside and you are certain there is nothing left to improve, use the money to pay yourself a bonus.
5. Altenatively, if the business is stable and advertising has proven not to pay off, you can pocket some of the royalty money. But, I’d wait a few years until the business is well established.

What you are giving up by not buying a franchise:

• a method to operating a business and buying inventory that has been shown to work
• existing brand awareness
• pooling advertising dollars with other franchisees
• knowledgable resources (though they are obligated to maximize their profits, not yours)

What you gain:

• Freedom in all aspects of operating your business, from site selection to operations
• Easily sell the asset (your business)
• Lower cost inventory (no franchisor markup or required suppliers)
• Higher rate of reinvestment of gross sales into business
• Investing the franchise fee can provide a nice retirement safety net

One big reason franchises succeed more often than startups is the franchisor requires discipline — discpline in capital requirements, discipline in advertising and operations. If you have the discipline, you can succeed on your own.

We report, you decide 😉

We already talked about Manly haircuts, now lets look at Kids haircuts. You already know that we like salon franchises because they are simple to operate, it’s fairly recession proof, labor costs are low and supplemented with tips, no perishable supplies, brand loyalty has been low in the past with Fantastic Sams and Best Cuts types being identical, and kids "experience" business are here to stay. Getting your haircut is usually not an experience one normally looks forward to, that why we believe themed salons are a great hook.

This is especially true for kids haircuts. Kids are all about the "experience" and have undeserved power in deciding where to go. Here steps in Snip Its. Check out their web site for a sense of how creative the place is designed. They cater to children of course, but also accomodate parents so the whole family can get their haircut simultaneously.

What are some special and creative attractions at this kids salon?

Glamour Parties
Snip-its Glamour Parties make girls gorgeous! A glamour party allows girls to act like divas for a day by offering hair braiding, curling and styling as well as nail polish and make-up application. Dressy clothes are provided to complete the look. The culmination of the party is a stroll on the catwalk followed by cake and favors provided by Snip-its. Snip-its even provides a camera to capture all of the fun.

Style-a-Doll Parties (Launching at Snip-its this summer!)
At Snip-its’ Style-a-Doll Parties, attendees each receive a doll inspired by Snip-its’ trademark characters, the Clipette sisters – Marlene and Charlene. The dolls have been specially created so that birthday guests can style their hair with hair clips and accessories and apply Snip-its’ cosmetics that are designed for use on the doll. Stylists are on hand to help the girls with the styles and teach them about their own grooming and styling. The girls get to bring home the doll as well as the makeup goodie bag as part of their birthday party package.

Upon entering the Snip-its salon, parents and children step into a magical, engaging, cartoon world of adventure characterized by floor-to-ceiling cartoon murals, splashy vibrant colors, music from the Snip-its soundtrack and larger than life animated cartoon characters, including Flyer Joe Dryer, Maranga Mirror, Curly Comb and Snips.

Sounds like a fun place, eh? I cannot vouche for the operations or profitability of a franchise like this, but salon-haircut franchises are typically relatively easy to operate profitably, and this one has an especially timeless and engaging theme that gives Snipits a sustainable competitive advantage. The idea is fun enough to take to local schools and charity events for extra promotions and profits. I think this is easily one of the top franchise I have reviewed so far. I’d buy it!

I rarely deviate from franchise talk, because that is what people come here to read. But, I just watched this heart touching tribute to former President Ronald Reagan on the 1-year anniversary of his death. I recommend people watch it regardless of their own political affiliation. Sometimes we need step back from business and keep perspective about what is truly important in life. Reflecting on great Americans can sometimes help us in that personal journey.

Some franchisors allow their franchisees to conduct their own promotions. Be especially careful of "free" coupon giveaways in whatever form. Subway is ending their free sub card (you need to get a certain number of stamps and you get a free sub).

There are some good Quiznos comments and debate about what are appropriate expenses.

CLICK HERE to see it.

read more Franchise Pundit posts on Quiznos…