Monday, December 29, 2008

Cold Stone's Strategy

Was it Cold Stone's plan to defraud prospective franchisees? Cheat them out of their life savings? Ruin families? Not in the beginning. The early years were both exciting and challenging. There were just a few employees in the fledgling company, and like many startups, they had their share of ups and downs. Doug Ducy often told the story about the first franchisee that signed up, and Cold Stone Creamery receiving their first franchisee fee! Finally, they could buy a brand new computer! Maybe some office equipment.....even pay themselves! Cold Stone Creamery had started to grow. So how did it all go wrong? What happend that changed the way Cold Stone would operate? One word.......Greed.

I’ve given this a lot of thought. Let me explain how I think Cold Stone’s strategy changed over the years. In the first few years of their growth, they indeed wanted success for their franchisees. There was lots of room for growth, and virtually no opportunity for impact from any competitors, or even other Cold Stones. And the company’s growth was way beyond expectations. Cold Stone was flush with money. They advertised for franchisees right at the store level, providing applications to anyone who wanted one. It didn’t matter if someone wasn’t financially qualified…they would loan them the money! This was a Bart Dunn strategy. Some of you who got in before 2005 remember Bart Dunn. If the borrower didn’t pay the loan back, Cold Stone would just take back the asset, and re-sell it! They did have an almost unlimited supply of people wanting a Cold Stone! After a few years of this, and a number of defaults on the loans, Cold Stone was experiencing some cash flow issues itself. It owned a lot of notes, but didn’t have a lot of cash. They hired in-house accountants, and fired Bart Dunn. Financially, Cold Stone was a mess. Their own in-house accountants told them that they weren’t a bank, and should not be lending money to anyone. All the notes were sold off. Hopefully, Cold Stone was now back on track financially. But sales were beginning to decline. Look, Cold Stone was aware that their business model wouldn’t work. The prices of the product we sold needed to be high enough to overcome the high cost of the debt load we had assumed. But the prices crossed over that threshold that customers would be willing to pay. If and when the economy turned down, no one would be willing to pay the kind of prices we needed to feed the machine. This wasn’t even considering the high costs of the raw materials we would experience.
The declining top line sales greatly affected royalty and advertising dollars that Cold Stone was receiving. They instituted programs whereby they could extract more money from their franchisees. They were already receiving money from the vendors, called Flexible Marketing Plan dollars. The more cases they could generate for the vendor, the more FMP dollars they would receive. Someone thought that by breaking up a case of strawberries from a 30 pound box to three 10 pound boxes would work. They never considered what the franchisees might say, or how inconvenient it would be. That is, until we all let them know! But they had just completed a new headquarters that was spectacular. They had to feed their machine too. They began a “guaranteed rent” program. It worked like this. They would be the primary lessee, and the franchisee became the secondary on the lease. They had convinced the franchisee that this was a good thing for both them and the franchisee. In the event that there were issues, the company, being the primary on the lease, would be accountable to pay the rent. For this “guarantee”, the franchisee had to pay them up-front, a 2% fee equal to the dollar value of the rent for the life of the lease, usually 5 years. For me, that amounted to about $6,000. What incentive did Cold Stone have to demand lower rents? After all, that would lower the 2% money they were receiving. What a deal for them! Not only did they get the immediate upfront fee, they collected the rent from us weekly, but paid the rent monthly! Besides, they included terms that would protect themselves if the franchisee bailed. The franchisee would still be on the hook for the rent, and personally liable. Presto, instant cash flow!But there was still that one important issue they would have to overcome. The unprofitable franchisee. And the number of unprofitable stores was adding up. At the most maybe 25% or 30% of the stores were actually profitable. This need to change if they were going to go public. But didn’t Doug Ducy stand on stage and tell all of us that Cold Stone had no intention of going public? Sure he did. But, how much sense did that make? There was too much to gain, and nothing to lose by going public. The gain was in the tens of millions of dollars. Not including what it would mean personally for himself, the Sutherlands, and a few others. The plan was quite simple, actually. Legal action would be taken by Cold Stone against any franchisee that financially violated the franchise agreement. Cold Stone would remove that franchisee, hopefully without a legal battle. Just walk in and take over those stores. They would resell each location for 50 cents on the dollar, maybe even less…put in a second generation franchisee that would be able to support the much lower loan amount, and the problem would be solved.Then along comes Kahala Corporation. For Doug, this was even better than he had hoped for. An injection of cash would come much sooner than he had hoped for. Most of the financial mess within the Creamery had been cleaned up, the number of stores was growing, and things, at least on the outside, looked good. Unfortunately for Kahala, they didn’t dig deep enough, until it was too late. The deal was done. It would only be a few months before Kevin Blackwell discovered what he had bought. Cold Stone Creamery represented 50% of Kalaha’s size and represented the biggest share of the total volume of the company. Unless he took immediate action, this could hurt the company he built. Prior to Kahala Corporation, Cold Stone had continued to grow its staff. We couldn’t even keep up with the personnel changes. They changed daily. Now, the reverse was taking place. Kevin had to reduce the duplicated staffing that happened once the buy-out was complete. Suddenly, announcements were coming weekly about someone leaving Cold Stone. These were the top positions within Cold Stone. We had no idea of the magnitude of the purge. Kevin’s goal was to replace most of the top line staff at Cold Stone with his own people. People he could trust. I believe that the Sutherlands were aware of the direction Doug had taken the company. It was time, they agreed, Doug had to go. They stood behind Kevin when the axe fell on Doug. Kevin had become aware of the situation Cold Stone faced with the unprofitable Cold Stone franchisees, but he agreed with the plan and the course of action already taken by Cold Stone, deciding to let it play out.That’s where I see Cold Stone’s strategy today. Maybe there is some conjecture on my part, but I have seen the actions taken by Cold Stone up close and personal. I know what they are capable of. They are not interested in helping the franchisees who are struggling. There is nothing in it for them. If you find yourself in financial difficulty, remember this. It is only a matter of time. At some point, all the money will run out. Someone will lock the doors on you. Start action now. Call someone. Listen to other franchisees or former franchisees. Get in touch with Cecil. Call me. Just do something before it’s too late. Also, remember, nothing is more valuable than your life or your family.

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