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Open New Franchises or Grow through Acquisitions?

Background on the Author – Patrick McKinney has experience in a variety of roles a multi-billion dollar franchise organization including leading strategy, M&A, marketing & sales, and operations functions.  Prior to the franchise business, Patrick worked for a Fortune 50 company where he focused primarily on international Strategy and M&A.  Patrick began his career as a consultant for McKinsey & Company. 

 

Your first franchise

Many franchisees open or buy their first franchise and invest endless amounts of blood, sweat, and tears to build their very own profitable business.  I have often heard from franchisees that opening the first franchise is typically the hardest; however, once they get that first location open, the desire to expand out into new locations sets in quickly.

Shared resources with multiple locations

This desire to expand is not a function of egotism, but rather the realization that there are many cost and revenue benefits that can be achieved by increasing the scale of a franchisee’s operations.  For example, a franchisee who opens his first quick-serve ice cream location maybe be able to better utilize fixed costs associated with things like operations management headcount, back office support (personnel & systems), and inventory warehousing by sharing these assets across multiple locations.  Another example might be a salon owner who is able to offer customers more times and more convenient locations by having multiple stores across a specific geographic area – this scale could reduce customer attrition and potential increase frequency of visit, driving incremental revenue.

You may be saying to yourself “that all sounds great, but what is the best way for me to expand the footprint of my business?”  Should I build new locations from the ground up (“Greenfield Approach”) or should I go out and buy an existing player in the trade area where I want to expand (“Acquisition Approach”)?  For the purposes of this article, I am going to focus specifically on the Acquisition Approach and will discuss rationale for why you may want to consider expansion through acquisition as well as a few key items to consider before pursing this approach.

Benefits to expanding through acquisition 

There are many reasons why you may want to consider expanding through acquisition, however, below are a few reasons that I have found to be the most compelling for franchisees.

1) Acquiring the best location in a market

Real estate is one of the most important drivers of success for many franchise concepts. Visibility, proximity to target populations, quality of facilities, and etc. are all important aspects that drive real estate selection decisions.  As we all know, real estate is a scarce asset and, therefore, it can often be difficult to find an ideal location for a greenfield site within a specific trade area.  If there is already a competitor in the trade area with ideal real estate, it may make sense for you to acquire that competitor vs. building your own location on less ideal real estate within that same trade area.

2) Starting a new business from a solid base

Building a loyal base of sticky customers that return to your business for their needs is often challenging and can be very costly. When one is thinking about entering into a new market with a new brand or different business model, acquiring new customers can be even more challenging and more costly due to low awareness, affinity/comfort with existing solutions, and general customer apathy.  One way to try to combat these challenges is to buy an existing player in the market and transition those customers to your brand/model while at the same time hunting for new business.  Although this deal rationale can be very successful, it can also be fairly risky if the transition from the legacy brand to your brand is not done thoughtfully.  The key to this deal rationale is truly understanding the customer and ensuring a smooth, transparent transition.

Key considerations 

Despite the many benefits of expansion through acquisition, the reality is that successfully acquiring and growing a business can be risky.  Below are a few key considerations to keep in mind when thinking about the Acquisition Approach.

Don’t get caught in the “distressed asset trap”

When I worked in the M&A group for a Fortune 50 company, my boss gave me some very powerful advice: “I am not in the business of buying crappy businesses, why waste my time when there are better opportunities”. I believe that this advice is extremely relevant to franchisee’s considering buying businesses that are priced to sell.  If a business is not doing well under current management, there is typically a very compelling reason why.  A change in management is likely not going to solve the underlying business issues and the amount of investment (financial & time) required to turnaround the business simply may not be worth it vs. your next best investment opportunity.

 Prepare for transition risk

Post-acquisition integration is by far the most challenging part of any acquisition. As a new owner, you will have to figure out how to maintain continuity of the business immediately after purchase, then how to implement you plans to improve the business.  Based on my experience, there are three primary transition risks that every acquirer should focus on:

1) People

High quality, customer service-oriented people are the lifeblood of any small business and the reason why customers come back to transact with the business. Identifying the key employees, understanding their needs/wants, and developing a plan to mitigate flight risk for key employees is absolutely critical for any acquisition.

2) Customers

Do not assume that the customers at the target business are the exact same as the customers at your current business. There may be specific aspects about the service that they currently receive that drive their behavior.  Before making any changes to the business model of the business you acquired, I recommend spending a significant amount of time with customers understanding what they value, what they would change about the model, and begin testing concepts.  Even minor changes to the business model without fully understanding the customer can have huge negative impacts on a customer’s likelihood to continue transacting – I have seen this first hand and it was not pretty.

3) Suppliers

Ensuring a smooth supplier handoff from current operations to your team is critical to a successful transition. Often time the suppliers have a lot of visibility into the challenges that the business faces.  More often than not, I have seen that supplier often provide incremental value in addition to the specific products or services that they provide the business.  In summary, proactively build relationships with the existing suppliers, engage those suppliers often, and do not be afraid to lean on the suppliers for guidance or help.

 Do you homework and know why you are buying the asset

Successfully executing an expansion through acquisition strategy truly hinges on preparation. This starts with clearly defining a thesis for why you should buy a location vs. building your own location.  A few questions you may want to ask yourself are:

    • Is real estate the primarily driver for acquiring?
    • Is the customer base the primary driver for acquiring?
    • What assets are you getting as part of the acquisition?
    • How will you better leverage those assets?
    • What other investment will be required to grow the business?
    • What are your other alternatives to grow your business?

As you go through the transaction process, take the time to gather as much information as possible to test the key hypothesis that you developed to justify the purchase.  Once you feel comfortable that you have confirmed your hypotheses, create a formal 30-60-90 day integration plan for the business and allocated resources for execution.  Proper preparation prevents poor performance.

Conclusion

Expanding your business through acquisition can be an extremely successful strategy – it can enable you to secure prime real estate and can give you a great customer base to quickly grow. However, this approach does not come without risk: spend the time to truly understand what you are acquiring and why you are acquiring the business, then ensure that you are prepared with a well-defined, measured transition plan.