Session 8: Growth By Duplication
Session 8: Growth By Duplication
OBJECTIVE: Duplication of a successful store concept requires management in a number of business disciplines unrelated to the operation of the stores themselves. Failure in any one of them could become a stumbling block. This session covers what you need to know before you expand by duplication.
- What is growth by duplication?
- Definition of duplication
- Small-scale duplication
- Large-scale duplication
- Examples of growth by duplication
- Businesses with questionable potential
- Businesses with good potential
- Importance of a successful pilot operation
- Management skills required
- Financing skills
- Create profit centers
- Management selection
- Accounting oversight
- Supervision oversight
- Real estate development functions
- Creating a site model for your locations
- Architecture and construction
- Leasing issues
- Rule number one
- A potential conflict of interest
- Legal issues
- Top Ten Do's and Don'ts
What is growth by duplication?
Definition of duplication
Growth by duplication is taking your present business and duplicating it in other locations. It's also called a "cookie-cutter" approach because as with a cookie cutter, identical cookies can efficiently be stamped out in either small or large numbers.
There is a margin of safety in pursuing this method of growth because your expansion does not take you outside your already proven circle of competence. You are sticking to what you know best and what you have already proven to be successful. This approach does, however, require some management skills beyond those required for operating a single location.
Growing the business that you have learned to do well doesn't mean that you should not always be trying to improve it. More often than not, good ideas for making improvements can come from outside your own operations. The best places to learn will be from your most successful competitors.
Sam Walton didn't invent the discount department store business; he learned it from Sol Price who was the pioneer of the industry with the Price Club stores in California. Here is how Mr. Walton put it.
|"I probably have traveled and walked into more variety stores than anybody in America. I am just trying to get ideas, any kind of ideas that will help our company. Most of us don't invent ideas. We take the best ideas from someone else."|
Assume you have a profitable business that is appropriate for duplication and your customers are located in a ten-mile radius. If you add another equally successful store outside that area (so you're not competing with yourself) you could accomplish two goals:
- Double your sales.
- Potentially more than double your earnings since some fixed costs are now spread over two stores and you have greater purchasing power.
To build a really large business, you will continue to expand over an increasingly widespread area. Your long-term goals could include:
- Franchising the concept.
- Public ownership.
- Become a candidate for acquisition by a larger company.
Examples of growth by duplication
Businesses with questionable potential:
- A professional or specialized practice (where your individual expertise is the cornerstone of the business).
- A business that requires high investment in machinery, upkeep, working capital, keeping up with the competition or any other reason. If you have borrowed money for the opening, debt repayment will be a major obligation.
- A manufacturing business where efficiency is based on centralization.
- A product or service business where the owner is the sole key person.
- Web-based/online businesses.
- Service businesses...but not all. (H & R Block does well at income tax service).
Businesses with good potential:
- Think about most any retail chain you know.
- Foodservices, especially fast food.
- Franchisors: McDonalds, 7-Eleven, etc. Please refer to the following session on franchising which covers how your business could become a franchisor.
- A firm that is geographically widening its market. For example, a wholesaler of plumbing supplies in San Francisco opens a branch in Sacramento...and over time grows to branches throughout Northern California.
Importance of a proven pilot operation
One cornerstone must be in place: your initial operation (or store) must have achieved a proven record of customer acceptance and profitability. It should be in operation for a sufficient time to have worked out flaws and a high probability of ongoing profitability. This will rule out fads or styles or businesses with short life-spans due to obsolescence or other reasons. You should have experienced profitable earnings for at least a year.
Management skills required
Duplication requires successful management in a number of business disciplines unrelated to the operation of the stores themselves. Failure in any one of them could become a stumbling block.
Opening a new store location will cost a lot of money. Assuming you are leasing the location, costs will include fixtures, equipment, tenant improvements, inventory, signage, lease deposits, working capital and other expenses. Your sources of funding will come from retained earnings or borrowing or both.
- When you borrow, if you can pay back in three years, then ask for a five-year loan...and not the other way around.
- Your cash flow projections should show sufficient cash flow to cover debt payments by a stated margin of safety. For example, your cash flow might be a multiplier of your debt service. Consult your CPA.
- Use a cash flow projection spreadsheet to project your future liquidity after making debt payments.
- Please visit "Where to get the money" in our financing session of the Start a Business course.
Create profit centers
Incentive plans will vary according to the business, but one essential component will be a system based on frequently calculated profit and loss statements for each individual store. Reasons include:
- The only way to truly evaluate a store is how it contributes to overall company earnings.
- Profit sharing provides the most powerful incentive for a store manager.
- The best managers want the incentive to reflect their individual successes, not on overall company results.
- A frequent, more imminent reward is more powerful than one sometime in the future.
- You need to know the financial results of each individual store in order to pinpoint weak ones. Losing a store should either be corrected promptly or spun off by sale or sublease.
A case study on a profit based incentive plan:
|Company "A" decided to vertically integrate by getting into the manufacture of its line of retail goods. An outstanding manager with all the qualifications was available but asked for 10% of the company's stock. Instead, a profit sharing plan was created for the profit center he was to run, giving him a 10% share in the profits. Over time, he made a great deal of money and flew his own plane. The company was delighted: it still received nine out of every ten dollars of earnings the manager produced.|
The success of your growth will depend a great deal on how skilled you and your human resource (HR) management is in selecting the best managers to run your stores. Mistakes made in this process can result in a huge drain on earnings. Here are some recommendations:
- Have a very highly qualified HR manager.
- Set up a standard process to screen applicants.
- The process should include testing that is specific to each position.
- Do not take any short-cuts in reference checking. Make sure the candidates have accomplished what they claim.
- Ask candidates the same questions so you can compare answers.
- Consider retaining an HR consulting firm that can customize the search process to your specific needs.
Our overall recommendation on hiring managers is quoted from Warren Buffett:
|"In looking for someone to hire, you look for three qualities: integrity, intelligence, and energy. But the most important is integrity, because if they don't have that, the other two qualities, intelligence, and energy, are going to kill you."|
Your accounting system will require a system of preparing frequent income statements on a store-by-store basis. Profit sharing payments should be disbursed to managers at the same time the profit and loss (P & L) statements are prepared. This will require your accounting department to develop procedures to accomplish this including inventory accounting. Some chains prepare P & L's every week. In cases where weekly is not practical, P & L statements should be published monthly.
Once you have opened your second store you are now a chain and will require some controls in place.
- A training manual in place for each job description.
- An operations manual so that each procedure is standardized.
- Central control of SKUs (stock keeping units).
- Central purchasing and distribution to stores. Store managers place their purchase orders with your central distribution facility.
- Central control of pricing, merchandising plans and advertising.
- A feedback procedure so that store managers have free access to central management.
- A supervisory plan so that stores are adequately monitored.
- Regular meetings with store managers to gain feedback and discuss strategies.
- Rigid disciplines as to service, handling complaints, uniforms, menus, etc.
Real estate development functions
If you continue to add more stores, you will also be in the real estate development business. Some of these functions include:
Creating a site model for your locations
We recommend you establish a site model for your particular business. Each business is different. The site model will establish an objective way to evaluate the various factors which make up a good location.Learn more about the step process of creating your own site model.
Demographics, especially population mix, will be important.
In some cases, copying the location criteria of a really successful competitor will be of value. If you're opening coffee shops, it could be helpful to know that Denny's are located at freeway off-ramps.
Architecture and construction
- In order to secure necessary permits, you will need an architect to prepare working drawings for the store including the tenant improvements.
- You will need a contractor to build out the store (assuming it is free standing) or construct the tenant improvements if it is in a shopping center. The landlord may be responsible for the tenant improvement build-out.
Rule number one: It is better to pay fair rent for a great location than to pay great rent for a fair location.
A potential conflict of interest
In the early stage of growth, you will probably outsource your site location responsibility to a commercial real estate broker who will act as your "site" person. But be aware of the conflict of interest which will exist when the agent's compensation is derived from leasing commissions. For example, the agent may strive for a 20-year lease instead of a 10-year lease with one 10 year option.
Any lease you sign for a second store will probably create the largest liability in your business. If you sign a 10-year lease for $10,000 per month with a 10-year option, over ten years, come what may, you will owe the landlord $1,200,000.
- Never enter a lease negotiation without your real estate lawyer.
- Never agree to a lease negotiated by either your leasing agent or the landlord's leasing agent.
- Require a right to sublet which shall not be unreasonably withheld.
- Better to sign a 10-year lease with a 10-year option than a 20-year lease.
- Negotiate for the landlord to provide tenant's improvements.
- Negotiate a go-dark clause in the event the anchor tenant leaves.
- Don't scatter your locations to make distribution, supervision and advertising difficult. Build-out one marketing area at a time.
Be sure that the name, logo, slogans and artwork you have selected have been cleared by your intellectual property attorney as being available. For example, wouldn't "Quality without Compromise" be a great logo? But it's not available because it's the intellectual property of See's Candy©.
Top Ten Do's and Don'ts
THE TOP TEN DO'S
- Stay in the business that's within your circle of competence.
- Stay within geographical limits you can service well.
- Prove profitability and systems before expanding.
- Bring in your lawyer for all real estate transactions.
- Build out one market area at a time.
- Verify that your name, logos and slogans are available.
- Compartmentalize your P & L's to individual stores.
- Calculate P & L's frequently for each store.
- Establish a real estate site model.
- Pay fair rent for a great location.
THE TOP TEN DON'TS
- Over borrow. Maintain 3-5 times cash flow-to-debt service.
- Pay great rent for a fair location.
- Risk duplication if you are the sole key person.
- Be in a hurry...instead, proceed with great caution.
- Overlook the importance of operating manuals.
- Let leasing agents negotiate your leases.
- Overlook the importance of demographics.
- Be vulnerable to Website-based competition.
- Give stock to managers: share the profits instead.
- Sign a lease without including recommended deal points.