In the past few years the fallout from aggressive brand consolidation plays in franchising is becoming more clear.
Mrs. Fields Famous Brands recently warned that it will file Chapter 11 within the next two months if it cannot persuade note holders to cut $145 million in debt by the end of June. The Salt Lake City-based franchisor of both Mrs. Fields cookies and frozen yogurt retailer, TCBY, has an annual interest debt-load of over $200 million.
Another franchise brand consolidator, NexCen Brands, announced in 2008 that it managed to stave off immediate bankruptcy proceedings after an interest payment on a sizable loan came due. NexCen, a franchisor of Great American Cookie, Pretzel maker, The Athlete’s Foot, and others declared in May that it had discovered the sizable loan’s unfavorable terms and realized it had insufficient funds to pay it. Its CEO warned it faced a severe cash squeeze and had “substantial doubt” that the firm would remain in business. Recent interviews From November 2006 through January 2008 NexCen went on a shopping spree, buying nine brands in 14 months. In the end, NexCen choked after the acquisition of the Great American Cookie franchise chain, when the interest on its debt was so large that it placed the company on the edge of insolvency. The firm’s new chief executive officer, Ken Hall, and his team miraculously managed to turn the franchising conglomerate from a $38 million net loss in Q3 of 2008 to a $1 million net loss in Q3 of 2009 but the Company still faces significant challenges.
These aren’t the only brand “consolidation” plays feeling pressure as a number of firms remain in the hands of private equity: with no means to exit in the foreseeable future.
Ted Pearce, general counsel of Meineke Car Care Centers, wrote the following in a May 2008 Franchising World article titled Post-Purchase Synergies: They Come in All Types:
“As franchise markets began to mature and there were more and more similar franchise systems co-existing within a market, franchisors found ways to further leverage their ability to gain market share by co-branding with complementary brands to capture a market segment that the systems felt they were missing. The present-day franchising world finds itself further consolidating under a common umbrella in an attempt to build efficiencies within a franchise concept and to realize synergies between these multiple systems.”
Efficiency is a great idea. Problem is most mergers don’t generate it. Here are some facts:
“70 percent of mergers fail to achieve their anticipated value…” – WEEKLY CORPORATE GROWTH REPORT
“Most mergers fail to add shareholder value-indeed, post-merger, two-thirds of the newly formed companies perform well below the industry average.” – HARVARD MANAGEMENT UPDATE
“A Towers Perrin study of 150 mergers of financial-services firms found that 30% of deals substantially eroded shareholder value, and another 20% eroded shareholder value somewhat…” – BEST’S REVIEW/PROPERTY-CASUALTY INSURANCE EDITION
“despite the well-publicized, much-analyzed fact that many of these mergers — up to 70%, according to some estimates — failed to create value, it seems clear that the end is not yet in sight.” – FINANCIAL EXECUTIVE
I was in franchise finance for a number of years and actually was involved in one of the earliest and largest merger acquisitions in food service history: Church’s and Popeye’s. I learned some valuable lessons first hand. While mergers might look good on paper, companies often fail to recognize the specific actions necessary to make two separate organizations behave like one. And the reasons for this are straightforward.
First, the people who focus on the acquisition are skilled in strategy, the industry and in finance. They have a very clear picture of the desired objectives of the acquisition, and understand how the new organization should return business efficiencies. But given the time demands of the pre-purchase activities, and their tendencies to focus on financial and business issues, the “people” and “systems” issues don’t receive the attention they should.
Second, the idea behind an acquisition or merger is to create shareholder value; to grow the business. Bottom line is many of these transactions are cover for a franchise system that has inherent problems which management believes growth can solve. But it doesn’t. Clarity around processes, systems and people are not achieved through economies of scale. In fact the problems created by operating multiple brands often outweigh the benefits.
Third, people most affected by the merger, employees of the purchased organization, do not know the business objectives, see change as a threat, have no real influence over the events, and wonder immediately how they will be affected personally. Not surprisingly, the focus and priorities of the two groups are likely to diverge starkly.
The main reason why more than 70 percent of business combinations fail is inattention to the messy, detailed, nuts-and-bolts issues. If management truly had their hands around those details they might not need to acquire their way to success in the first place. Facts are that even “smart” “experienced” franchise brand managers are not as capable as they might think at dealing with the nuts-and-bolts. Having consulted with a variety of franchise executives, many whom have been touted in industry rags as being gurus, I can say that few possess deep understanding of their own franchise system let alone the ability to ascertain the workings of another they are thinking of acquiring. Therefore, to the extent consolidations continue as a strategy reflective of a maturing franchise marketplace, folks should remain highly skeptical of mergers as a means to realize efficiencies that create value.