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How the Serruya Family Made Big Money on Shrinking Franchise Systems

Melting ice cream (photo by teakwood)

The Serruya family has bought Kahala for cheap at an auction and quickly traded the franchising conglomerate of such troubled brands as Cold Stone Creamery and Blimpie to the MTY Group for a whopping $320 million in cash and stock.

Serruya says that he had sought the deal with MTY's founder and CEO Stanley Ma, who he had known for more than a decade and who is a Canadian franchisee for Kahala's TacoTime brand, and the two had been in discussion for a year and a-half. The deal will allow Ma, who the Canadian press dubbed the food-court king and who built MTY through a series of acquisitions to a company with 40 brands like Vanellis, Mr. Sub and Kim Chi Korean Delight that few Americans would know, to expand to the United States. (Ma declined to speak for this story.)

Franchisees don't seem to know much about the deal yet. Grabenauer, the Sonoma County franchisee, says she received a short email. Kyle Turner, 24, who started at Cold Stone out of high school in Amelia Island, Fla., and last summer bought the store with a partner, says he wasn't even aware that Kahala had agreed to sell – though he couldn't be happier as a new franchisee. "It doesn't really affect our day-to-day operations. It just shows that we're in such different worlds," Grabenauer says. – Forbes

Source: FDD

It is a great article by Forbes' reporter Amy Feldman. I highly recommend reading it.

For MTY, this merger promises the big apple, America, for its dozens of Canadian brands. Sitting on its southern border is the world's largest economy with a larger group of franchise buyers than anywhere else. The number of people to sell franchise licenses to and then collect their royalties down there boggles the mind. And then there is selling co-branding licenses to existing franchisees. Think of a Cold Stone Creamery store to cool down a mouth after a customer has eaten from the Kim Chi Korean Delight menu.

Shareholders no doubt are delighted.

Here is my take on what this means to Kahala's and MTY's franchisees.

It will mean less of what franchisees have received so far.

For one, Kahala's franchisees will be in a bigger "asset-light" system without any franchisee governance structures. That is dangerous because franchisee structures are meant to guide and push back a blind franchisor who has no retail business of its own. MTY and Kahala will continue to use a top-down command system borrowed from corporate organizational structures of the nineteenth century and grafted onto the franchising world. The good news is that franchisee advisory councils will continue to give advice to a hopefully willing but more distracted franchisor ear, which with a bit of luck won't penalize a franchisee that speaks frankly on what she and her customers need. But even here, being able to speak frankly, and the ability of franchisees to do something about it are two very different things.

Chart: BMM; Source: FDD

That is why franchise governance structures were invented.

The mainly single-unit franchise owners of Kahala have no cooperative, that is to say a firm that they all own, to direct and push down costs or minimize markups in Kahala's supply chain. The franchisor is more indirectly incentivized to minimize supply costs than the franchised retail shops are. The franchisor will handle all of this.

Without a franchisee advertising cooperative, the franchisor will be able to market the brand with carte blanche. That's a recipe for some major marketing flops. When it flops too many times or the retail units continue to lose traffic, it will want to raise marketing fees from its franchises. The franchisor in its ivory tower will naturally blame franchisees for not following its idealistic standards of what retailing should be – as if it should know. It will want to crack down harder on franchise standards.

Blimpie U.S. franchised restaurant count
Source: FDD

There is also a silver lining for for franchisees in the small brands. In a franchising conglomerate, the big brands –e.g. Cold Stone Creamery, Blimpie, etc.—tend to subsidize the marketing efforts for the little guys, such as cereal bowl restaurant Cereality. Unfortunately, for franchisees in the moderate to big brands, there is a lot more brands to spread around your money.

It is hard to imagine it but Kahala's brands have no effective independent franchisee association. The franchisor is free to command the franchise on how to run its store. And it will push towards "synergy" in which it can merge supporting staff of its fifty brands to lay off franchise field operations and other supporting staff from your brand. That is a nice short-term win for the franchisor in that it saves the franchisor costs for supporting franchisees. But the brands risk further shrinkage of units. That is the marketplace's way of voting with its feet that it thinks the brand, and your store, are becoming more and more mediocre. With luck, Stanley Ma and MTY can sell the portfolio of ever-growing franchising firms.

These will be the things that I will be especially mindful as I continue to watch these franchise systems.

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email don@bluemaumau.org.