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Post-Purchase Synergies: They Come in All Types
May 2008 Franchising World There are endless possibilities in organizing a multi-brand company that can take advantage of a variety of cost-savings measures that will contribute to the overall profitability of the multi-brand company. By Ted P. Pearce Over the past 40 years, franchising has undergone dynamic changes. In its infancy, the developing franchise systems were truly entrepreneurial with unique ideas coming in rapid succession to fill the post-World War II vacuum of pent-up demand for services to meet the changing tastes and needs of the American public. Like any other market force, franchising has changed with the times. In the 1970s and 1980s, the concentration was on growth of individual systems. As these franchise systems became more mature, franchise managers found new ways to leverage their acquired expertise. In some cases they developed parallel systems to complement the offering of their flagship systems. In other cases flagship systems were acquired by strategic purchasers who believed that these franchise systems were a good vehicle for the distribution of their products and services.
Realizing Synergies Usually when a company markets itself, it establishes a selling value based upon a multiple of its earnings before interest taxes, depreciation and amortization or EBITDA. In addition to this valuation, the seller will often try to increase the valuation of the business by marketing the fact that what he is selling is actually worth more than the EBITDA. Through the sale the buyer will realize certain efficiencies and savings by consolidating some of the functions of the target company with the other franchise companies already in the purchaser’s portfolio. These synergistic savings can be of all types. From a very basic level they can include certain non-essential expenses that a selling company shows in its profit-and-loss statement. These basic savings may include items such as club memberships, airplanes and other employee perquisites.
Opportunities for Savings
There are numerous synergies that are available to franchise companies operating under the same corporate umbrella. These synergies can be divided into what can be called back-office and front-line synergies. With respect to back-office synergies, even if the franchise system being purchased offers dissimilar products and services from that of the flagship franchise, there are plenty of synergistic opportunities. Whether or not the franchise systems offer similar products, there are certain administrative functions that beg for consolidation and transcend the character of the products and services within the two or more franchise systems at issue. Within the venue of real estate, while the parameters of an acceptable location for one franchise system may be different from another, these differences can be easily learned. One caveat to combining this function is to determine if the systems owned by the single franchisor are competitive. If they are, one must be sensitive to the argument that finding a good location for a franchisee of one system may be done at the expense of a franchisee from the other system. Likewise, in franchise development, the franchise sales team must be cognizant of the potential skills of each of the franchisee applicants to direct him to the system where he has the best opportunity to excel and not the system for which the franchise development person maintains his allegiance. Stacking one system with the most qualified franchise leads may be good for that system, but it will leave the other system weaker.
Creating Shared-Administrative Services This synergistic model may in fact work, and there are franchise systems with multiple franchise systems that incorporate this model. However, the leader of the franchise system should ascertain whether this approach is even-handed and provides each franchise system with the same advantages or whether the services being provided by the franchisor are being diluted. Will the advice and counsel that is being given to one system bleed over to the other system? Will the services being performed for both systems truly be equal? Will the same number of visits that were being performed before the purchase of the acquired system remain the same or is there a noticeable difference of service as a result of the operations representative being shared among two systems?
Synergistic Possibilities and Challenges Ted P. Pearce is vice president and general counsel of Meineke Car Care Centers, Inc. He can be reached at 704-644-8130 or ted.pearce@meineke.com.
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.
The word “synergy” is of Greek origin, which originally meant working together. Webster’s dictionary defines synergy as “a mutually advantageous conjunction or compatibility of distinct business participants or elements (as resources or efforts)”. In today’s market, franchise systems are combining under a single franchise platform trying to leverage these synergies that will enable the particular franchise group to become effective and efficient brand managers. Now longer are franchisors satisfied in growing a market under the umbrella of a single-service purveyor. Currently franchisors, or their holding companies as the case may be, see themselves as multiple-brand managers that can cross-market segments using their expertise in their flagship systems to leverage other franchise brands.
Private-equity groups and venture capitalists have targeted their franchise investments in different segments of the economy. In seeking out these investments, they look for targets that not only will add consolidated top-line revenues, but also will increase the multi-company efficiencies that will translate into consolidated and decreased expenses thus leading to higher-profit margins. Whether it is in the quick-service restaurant industry or the automotive aftermarket, each transaction will be examined—and even valued—with an eye toward the available synergies, as well as the added sales revenues and cross-market revenue opportunities that can be derived from these consolidations.
Beyond these very basic cost savings there will be examined more opportunities for savings through employee consolidation and other items. It is likely in any purchase transaction that the acquiring company’s chief financial officer will look at every facet of the two companies to squeeze out non-essential expenditures to realize the best possible synergies. In evaluating a purchase of the company, the acquiring company will value its investment based on the return of investment, more commonly known as ROI, and how long it will take to realize the return of 100 percent of the purchase price. Accordingly, to realize a targeted EBITDA on a post-closing basis the acquiring company will model in its budget the synergistic savings it believes that it can realize.
Some of the more common administrative functions that are ripe for consolidation are accounting and legal. Every franchise system requires the preparation, renewal and periodic amendment of the franchise disclosure document, formerly the UFOC. It is certainly possible and preferable to consolidate the two legal teams from the separate franchise systems and combine the preparation of legal documents through one coordinated legal group. Likewise, other legal functions that are part of any franchise system, such as trademark management, resales, renewals, and enforcement proceedings can be performed from a single legal department with one general counsel at potentially significant savings.
In the accounting area, the synergies that can be realized also are significant. Franchise accounting functions such as collections, balance-sheet preparation, and budgeting can be done with a combined or single accounting staff under one and not two chief financial officers. Other areas behind the walls of franchising that are primary targets for consolidation after an acquisition would be real estate, customer service and perhaps even franchise sales or development.
Quite often, unless the corporate culture of both franchise companies is integrated, loyalties to one system may prevail over the other to the detriment to one of the franchise systems. Integrating two corporate cultures may prove less difficult if the host franchisor combines these overlapping administrative functions in a separate division such as shared-services. In this manner the employees handling this function are not legally tied to any one franchise system. Moreover, the budget for this division would be based on the servicing of all systems and bonuses or other compensation benefits would be based on the manner that the administrative services are carried out between all of the member companies.
In addition to these shared-administrative functions there are other franchisor functions particular to a single franchise system that may lend themselves to consolidation with two or more systems. However, these very franchisee-visible functions may be somewhat trickier to combine. These frontline functions of operations and marketing, while lending themselves to synergistic combinations, need to be handled with care to make sure that both systems receive services that are equal even if they are not separate.
Most business-format franchise systems use a group of what is commonly-known as operations representatives who visit and work with franchisees in a franchise system. These visits can be used to both police the system, as well as to assist franchisees in building local sales and their profit potential. Often these representatives will convey new franchisor programs to the franchisees in an attempt to provide each franchisee with a competitive advantage over the market competition. After a purchase of another franchise system, it is very tempting for the franchisor to use the operations representatives from one system to perform these functions for the newly-acquired system. Certainly there are many synergies to be realized by not having an overlapping network of the franchise representatives. Savings can be realized with fewer representatives and expenditures in the form of travel, employee benefits and other administrative costs. The rationale for using the same operational representatives for both systems is that the operations function is fungible and that once the franchise representative learns the newly-acquired franchise system it will not be difficult for him to replicate the functions for both systems. Further justification will be based on the assumption that each franchisee, no matter what system he may be a part of, has the same profit goals and that his business lends itself to the same economic components, including fixed costs for land and labor, and the same needs when it comes to evaluating gross-profit margins.
One of the things that an acquiring franchisor should look at before making an acquisition is whether their franchise agreement or the agreement of the franchise system to be acquired contains any franchisor non-compete language that would prevent either franchisor from offering any operational direction to an affiliated or subsidiary company that offers the same or similar products and services to the other franchise system. The more similar the systems that are being operated by the master franchisor the more likely that this concern will be extant, and the more caution will be needed in organizing the operations of the two systems.
Like operations, the handling of a franchise system’s marketing and advertising functions also provides synergistic possibilities and challenges. How a franchisor markets its products and services to its target consumers is a core component of any franchise system. Often the person in charge of this function is a highly-skilled and paid franchise executive. The most natural temptation of any multi-system franchise company is to combine the marketing and advertising functions of the multiple-branded company under one department or marketing executive. From a purely synergistic viewpoint one cannot argue against the business justifications for combining this function post acquisition. In addition to the cost savings that will naturally flow from this combination, there are opportunities to devise methods for cross-promoting both the various brands under the multi-brands’ franchisor’s umbrella.
Notwithstanding these efficiencies, combining the advertising function of a multi-brand system will call into question whether one system that has not previously been a beneficiary of this combination is receiving a competitive advantage at the expense of the other system. When a marketing officer implements a successful marketing strategy for one brand that may differentiate it from another, will that strategy lessen the competitive advantage of the brand that they originally serviced?
As the consolidation of franchise systems under one umbrella becomes more popular, the multiple-brand manager should expect more resistance from franchisees who may question whether the combination provides them reduced services. It behooves multi-brand managers to find ways to avoid the perception, or reality as the case may be, of information sharing that could serve as a disadvantage to one or both brands that are relying on the expertise of the particular market officer.
Exploring the synergistic possibilities of operating a multi-chain franchise system is nothing less than peeling back the skin of the proverbial onion. There are endless possibilities in organizing a multi-brand company that can take advantage of a variety of cost-savings measures that will contribute to the overall profitability of the multi-brand company. In many cases these efficiencies make business sense, and in fact contribute to a more efficient operation. The information-sharing that is available across system lines can be both a benefit to the ultimate franchisor and the component franchise chains. Notwithstanding these savings and efficiencies, a savvy franchisor also must evaluate the effect of these synergies on the overall competitive position of the individual chains that will be directly influenced by these savings. There is no sign that the pace of franchise consolidations is slowing down; thus the examination of synergies that these multi-chain franchises can apply will continue to be top of mind for both franchisors and affected franchisees.
