A Crack in the Cup

Chapter 3

Cannibalism

It’s a strange word to be used in a business context. Images of horrible mutilation and death as parts of a human body are eaten don’t fit. It’s simply part of the jargon we use. If a new product is introduced and it takes away from the sale of an existing product we say “it cannibalizes it”.   If a new store opens in the vicinity of an existing store and negatively impacts its sales and customer transactions , we say it cannibalizes it, usually expressed in dollars or percentages. However, when the store owner’s pocket book gets a big bite, they are expected to suppress any emotion for the sake of the brand which eventually erupts as some of those primal instincts resurface.

This chapter explores cannibalism in our business as it progressed from a gentle nibble to bite size pieces. We are now at a point in many communities where we must ask when is enough enough. How much of the body can be nibbled away until it can no longer heal?

There are realities in the franchising business that have always existed and always will. First, as developers and stewards of the brand, the franchisor must operate from a position of power. It has to be that way. The franchise agreement is thick, full of legal language and tends to spell out the franchisees obligations in considerable detail. Franchisee rights are included but are minimal. There is legislation in all provinces of Canada designed to offer some protection for franchisees under what is known as the “Arthur Wishart Act’. It is weak legislation that has not kept pace with the ongoing tightening up of franchise agreement by franchisors. Franchisees that challenge what would seem to be an obvious violation of the agreement has a high risk failure in addition to high legal costs. Franchisors have deeper pockets. Many cases are brought forward with an emotional driven sense of being morally wronged. The legal document outweighs past reputations, promises and practices, moral or otherwise. The success rate on franchisee litigation is very low.

Generally if someone is interested in buying a franchise they take the franchise agreement to their lawyer for an opinion. Legal advice frequently goes something like this, “run from it as fast as you can and don’t sign it”. Often the advice they paid for gets ignored and the agreement is signed, simply based on trust. The trust is based on a reputation built up over time, often decades as with Tim Horton’s. Despite a very one sided franchise agreement, franchisees that do their homework by searching out and talking to several existing franchisee first, consulting with an accountant familiar with that business and a lawyer that can explain the risks, they can still do very well. Buyers beware. Conditions can change faster than perceptions when new owners arrive with a new priorities.

Cannibalization:

The first Tim Horton stores opened in new territories or at least a fair distance from existing stores. Sales in existing stores weren’t impacted and generally if a second store was planned for the same community it was offered to that owner.

As the chain grew, a new problem emerged. If a new store was planned that fell between two franchisees both franchisees would be impacted by lost sales to the new store. In our jargon it would cannibalize the sales of both. It could only be offered to one franchisee. Initially it generally worked out okay with agreements reached between the franchisees. However, gradually as the number of stores increased and communities became saturated the stakes became higher. Franchisees goals were no different in that they wanted to grow and they wanted to control their market.

The fear of losing a substantial amount of sales when a new store opened nearby became a friction point between franchisees and between franchisees and head office. There was a winner and a loser and nobody likes to lose. Through the 70’s, 80’s and 90’s any friction was somewhat mitigated by the huge year after year sales increases. If a store took a 10 or 15% hit in sales they would have it back within a year or two. Sales increases in the double digits became the norm. Guidelines were set up to help decide who would qualify for the new store. It was imperfect, allowing for considerable discretion which tended to foster an underlying feeling of favoritism being shown to certain franchisees. I believe that in some cases that could be true but overall there was a conscious effort to be impartial.

Territory franchises were not granted. The reason goes back to the first few stores when a couple of franchisees were granted territories. Those early franchise agreements were lacking teeth. Franchising in Canada was fairly new. Unfortunately these were not good operators so allowing them to expand with more stores was not a good option. Termination of the agreements on an operational default was not felt to be enforceable. The problem is the agreement did not allow Tim Horton’s to expand in that territory without the franchisees permission. Stalemate. Now this territory was vulnerable to competitors opening up without a challenge. Needless to say once the 20 year term expired; the territory rights were rescinded.

Participating in a cannibalistic expansion sounds terribly unfair and mean spirited. But going back in time to the 70’s and 80’s it was a necessary method of both promoting and protecting the chain. Although by the mid 70’s Tim Horton’s had already leapt ahead of its competition, there was reason to be concerned. The huge Duncan Donuts chain from the U.S was trying to establish itself in Ontario and the Maritimes. They were already dominant in Quebec. Country Style Donuts entered the 70’s with more stores than Tim’s and was still expanding, Mr Donut had a number of stores in Canada, Robins Donuts out of Thunder Bay were aggressive in the West and starting to move east and several small chains were starting up. There was a race on.

In the 70’s the Tim Horton package was working well but expansion was slow at around 8 to 10 stores a year. The execution at store level was superior to any competitor but I recall after a day of store visits Ron shook his head and muttered “We’re just the best of a bad lot”. With a real threat of serious competition he fretted about how to ensure Tim Hortons reached top of mind with consumers. In the 70’s, a community of 30,000 was considered minimum to support a store. That was the current benchmark. How that has changed! I think it must have felt like one of those nightmares where you find yourself trying to cross the street, a big truck is coming and you can only move your feet in slow motion. Sure it was now a national chain but with 100 stores scattered from St. John’s Newfoundland to Burnaby B.C there was no critical mass anywhere other than perhaps Hamilton. The advertising fund was growing with every new store and became sufficient to produce commercials for radio, buy targeted airtime and rent some billboards. There was an obvious void between hearing a commercial and finding a store. The only real answer was to ramp up expansion, push operation excellence in existing stores and be very vigilant in cutting off competition before they could be entrenched in our market.

Imagine the world at your feet, with a limited budget to grow and a very lean mostly inexperienced staff. There was no model to follow. It was pioneering all the way. There was a sharp awareness that the window of opportunity was now and that it wouldn’t wait forever.

So in the Joyce years of Tim Horton’s expansion, cannibalism was actually good for the whole chain. Saturation in many communities didn’t happen until the mid 2000’s. With growing Canadian awareness, sales were breaking records year after year. The growth in the advertising fund allowed a leap into the big league. Television commercials were finally within grasp by the 80’s.

When I joined the Tim Horton team in 1977 there was one store in Burlington Ontario. It was store number 5 located on Plains Road and owned by Eldon and Doreen Fawcett. Ron approved two new locations in Burlington to open in 1978. It was a big step for both Ron and Eldon as they were both concerned about what this would do to store number 5 sales. These two new stores were miles away on the other side of town and both were sold to Eldon. I don’t believe store 5 sales were impacted. Both of those two locations have since closed and relocated to better real estate accommodating a drive through. This venture became a new benchmark for safe expansion.

When I became a franchisee in 1994, there were approximately 8 stores in Burlington. At last count there are 29. I soon experienced a couple of things that other franchisees could relate to. First, franchisees in the area resented a new franchise being granted a store in their area, particularly to a former corporate executive. Ron took flak for it on my behalf but I could feel the resentment. Fortunately, my location had an impact on only one other store nearby that was hampered by difficult access and no drive through. I was too busy learning how to run a busy store to give it much thought at the time.

Second, I learned firsthand the real impact of a new store opening close to me. I had the good fortune of acquiring what turned out to be a high volume, very profitable location. The bank allowed me to leverage the cash flow to finance the purchase of new franchises. Within a short time I owned and operated 6 restaurants, two of which were doing amazingly well. When a new store opened close to my breadwinner the proverbial shit hit the fan. The new store cannibalized my sales by 13 %. That was within the area of acceptability I had preached when I was in corporate management. What I hadn’t anticipated was a drop in profit of between 35% and 40%. The fixed costs didn’t go down, adjustments in staff hours were minimal and the gravy was gone off the top. This caused a chain reaction that almost led to bankruptcy. The bank told me I was now offside in my debt to revenue requirement and insisted rudely, I must say, to get it in order immediately or they would force sale of my assets even though I always made my payments on time. I can only forgive the cold, ruthless, unreasonable, greedy, self serving, psycho bully that handled my file because Christ tells me to. It is certainly not natural. At this particular time corporate had switched to electronic banking and were aggressively tightening the payment terms and bringing receivables current by taking funds out of franchisee accounts. In the midst of this I was audited by CRA and reassessed on some travel expenses. It was a perfect storm with the tsunami wave hitting on a Friday. My wife and I had to be very creative to survive. That is a story I will reserve for my grand kids or another chapter.

We did survive and eventually prospered. We accepted it as our own fault for naively trusting and not taking worst case scenarios into consideration. I was so eager to expand that I ignored the danger signs. In this crisis I was painfully made aware that new owners are not bound by a previous owners promise. On the positive side, we actually became better operators and business managers. It opened my eyes to the stress franchisees undergo faced with cannibalization which at times I imposed on others. In fairness, at that time, Burlington needed more stores but not that one.

I recently checked my store records for 2001 the year before the store up the street was opened. Multiplying the customer count that year by the average dollar transaction anticipated for 2017, the sales would now be approximately $5,000,000 per year, almost 65% above its sales today. This is an educated guess not having access to those store numbers since 2014 when I exited the chain. Might have been, could have been. This is really not relevant other than to show the impact cannibalization can have. I can’t disagree with cannibalization in principle. It has been important in the development of the brand but I do know that it poses real dangers for franchisees and the whole chain if not managed responsibly.

By the late 80’s the competitive danger really wasn’t a major factor. Country Style was no longer growing, Robin’s were sold and started dropping in quality and significance, and Dunkin gave up expanding in Canada partly because of problems they were facing in their own organization. We were starting to make inroads in Quebec. Yet the competitive factor remained a corporate obsession. It is still a driving force often used to justify opening more stores in already saturated markets.

There is a compelling argument for RBI to push expansion as shown in this example. I have not used actual stores but this exercise makes the point:

Two stores are each doing $2million a year in sales. On $4million total sales, corporate collects 3% royalty, 3.5 % advertising 10% rent and distribution revenue (not profit) of roughly 27%. That is a total of 43.5% of the franchisees sales of the top for a total of $1,740,000. Let’s assume the impact of the new store on the two existing stores is 20% or $800,000, divided equally between them and the new store does $1,600,000 in sales. Three stores sales now total $4,800,000 which generates $2,088,000 in corporate revenue an increase of $348,000 or 20%. The existing stores EBITDA drop by 20%. The purchase cost of the third franchise at roughly $500,000 and needs to be financed. There are now three below average stores struggling to build sales. Unless the same person owns all three stores, there is a serious cut in pay. This is a very strong motivation to search out new locations as long as the investment adds net revenue without causing store failures. There is no data to show what the long term effect will be as individual stores get squeezed but the current climate should be a good test.

Taking a snapshot today, there are real challenges. Competitors and particularly McDonalds are taking a serious run at the coffee, breakfast and baked good categories. Tim’s has to step up to the plate, freshen up, clean up and stay modern. They need to look successful. Passing through a littered, stained, overgrown drive through does nothing to make me want to come back. That just makes me assume the kitchen is the same. Bad operators need to be retrained or turfed. It’s an age old struggle. Do you decrease crime by hiring more police or by increasing people’s income and self esteem? If the product Tim’s sell has lost its point of difference, then it’s time to focus on the supply line and get it back. If the trend of flat sales continues and operating costs continue to rise, franchisees instinctively take steps to offset it by cutting in the only areas they have any control; labour and maintenance. This has a domino effect. Reinvesting in modernizing stores, maintenance, landscaping and renovations gets stretched. Tim’s main competitor, MacDonald’s, have 8 stores in Burlington versus Tim’s 29, all 8 are doing well with the exception of perhaps one located inside a large store. As an observer, I have the impression they still invest heavily in renovations, landscaping and staff.

Winston Churchill said and I quote, “However beautiful the strategy, you should occasionally look at the results”.

The strategy was good at the time. It made sense and worked in the 70’s, 80’s and 90’s but someone forgot to connect the dots. Customer counts per store started declining in the early2000’s

A challenge facing foodservice in general is coping with the costs of staying fresh. It costs the same to renovate a low volume store as a high volume store, it costs the same to landscape a low volume store and overhead costs don’t decrease as sales decline. It is a challenge. Perhaps the model will change again.

In the expansion drive in the 80’s a couple of offshoots from cannibalization developed. Low volume stores that would not support a one store owner were assigned to a multiple store owner. This would ensure the store would remain operational and a multi store owner could absorb a low profit store. Initially it was to ensure competition couldn’t get a foothold but eventually as Tim Horton’s dominated the market it became more of a profit generator for the franchisor. The franchisor collected 3% royalty, 10% rent, 3.5% advertising and markup on product. This encouraged keeping all stores open. A small number of low volume stores have been closed over the years but only upon expiry of their lease.

The growth of multi store owners was a positive force in the early years. Franchisees that were entrepreneurial were key players in developing new stores in their community. Gary and Mary O’neill in Moncton, Danny Murphy in PEI, John Hoey in Mississauga, Jeff and Heather Agnew in Kingston, Bob and Cathy Noble in Toronto are just a few examples of franchisees that built a small empire in their partnership with Tim Hortons.

Along comes tribal warfare. The small franchisee and low volume store increasingly become casualties of a newer threat of cannibalization. The willingness of the multi unit owner to take on more and more stores has created a two class system within the franchise body. Suspicions, jealousy and self preservation are eroding the “help your brother” attitude. The biggest competitor a Tim Horton franchisee has is another Tim Horton franchisee. This competiveness doesn’t fall on deaf ears at the corporate level. A house divided cannot stand. Alluding opportunities for more stores are enough for many franchisees to ignore their fellow franchisee. As smaller franchisees fall off the map, opportunities are created for the larger operator. As one multi unit operator said to me “I have more staying power so I will survive the peaks and valley’s”. The player with the biggest pot will eventually win. So perhaps in a time of rising costs and declining profits the role of the multi store owner will gain momentum.

Again quoting from Winston Churchill, “an appeaser is one who feeds a crocodile, hoping it will eat him last”.

It is unfair and not factual to paint any group of franchisees with the same brush. I personally know several franchisees that believe in and support RBI. I know multi store owners that fight for and support their fellow franchisees. There are franchisees working with RBI determined to resolve issues and work through major problems. They are dedicated, still believing in the founding principles…and the fun of making money. For the thin skinned loyalist it is a lonely position but moving from the barn to the ball room can be an intoxicating experience. Every franchisor covets such loyalty and cultivates it. But wounds are opening up that will take strong leadership to heal. These bumps to the cup are tearing out the heart and soul of Tim’s. Franchisees devouring franchisees will destroy the community developed trust.

Just prior to the sale to 3G, TDL started to downsize head office staff. That was inevitable as the hiring ramped up after the Joyce era at a hectic pace. It was no longer lean but this was the first time in its history a large scale firing took place. A former employee that attended the meeting told me that when the CEO was questioned about the impact on the Tim Horton family his response was “we are not a family, we are a business”. As he pondered that comment he said “oh my god, this is the end of Tim’s and welcome to the so called Global Economy.”

 

Stay tuned. Chapters to follow:

*Community

*irony of death in the path of a business

*how to squander points of difference

* History of 3G Capital