Pick the Wrong Partner II

This week the Redskins released tight end, Chris Cooley. Cooley was the team's career leader in receptions by a tight end. The Redskins released him, because he suffered chronic injuries to his knees. An NFL tight end is finished when his wheels go. At age thirty, Cooley's knees were unlikely to ever completely heal. His release was unfortunate, but understandable.

The real head scratcher of a roster move was the signing of Baltimore Ravens castoff place kicker, Billy Cundiff and the release of incumbent kicker, Graham Gano. The two kickers have similar accuracy, or more accurately, inaccuracy statistics. Gano is twenty-five years old while Cundiff is past thirty. Kickers, unlike wine, rarely improve with age.

We will remember Dan Snyder's tenure as owner for the team's inability to judge talent. No place has that failure been more pronounced than the inability to find a general manager with the talent to find talented players. A team's general manager is so important that some NFL teams award ownership stakes to these talent scouts. A good general manager is a valuable partner.

Are you relying on business partners that you would never consider actual partners? If you are a franchisee or a value added reseller (VAR) for a vendor, you have a not always silent partner. Your franchisor or vendor may not own actual equity in your business, but you have a partner nonetheless. Your selection of these non-equity partners is every bit as important as selecting equity partners. Relying on a relationship with the wrong vendor can destroy your business.

Tim owned a medical supply wholesale business supplying home health care providers with everything from adult diapers to syringes and bandages. A wholesaler is a middle man. Tim bought large quantities of medical supplies from manufacturers and sold in small quantities to the end users, who were home care nurses and other home health care givers.

Tim's gross profit on sales averaged 25% to 30% and his business grew to almost $4 million in sales per year. Tim's gross profit was his sales less the cost of the medical supplies. So he had a little over $1 million per year to spend on overhead and his compensation. He wasn't getting rich, but made a nice living earning in the $150K range.

If you're ever sitting on a park bench in Yellowstone National Park eating a yummy ham and cheese sammich, and a grizzly bear takes a liking to your lunch, you can expect that he will get it. That's what happened to Tim. The manufacturers of the medical supplies that Tim sold coveted Tim's gross profit. There should be a Biblical commandment along the lines of “Thou shalt not covet thy neighbor's wife nor his gross profit.” But there isn't. I think the actual commandment goes something like, “Thou shalt not covet thy neighbor's wife nor her ass.” I could be wrong about the exact wording.

The manufacturers decided to sell directly to Tim's customers. In a year, Tim's sales went from $4 million to $2 million. The next year Tim couldn't cover the rent on his warehouse, and he closed the business. From this incident, I came up with the saying, “Show me a small wholesaler, and I'll show you someone in financial trouble.” That line is copyrighted. You may use it only by crediting me with this incredibly astute business observation. Modesty is my best quality.

Tim's wholesale business isn't the only type that can be afflicted by the Biblical sin of coveting thy neighbor's gross profit. Franchisees suffer from the the same affliction. The typical life cycle of a franchise is as follows. The franchisor develops the first couple locations to prove the business concept. Then the franchisor sells as many franchises as possible to extend the reach of a proven business model. Why does the franchisor sell franchises if the business model is so good? Because the franchisor typically lacks the capital to expand to fill the market.

However, once a franchise business model proves effective, the franchisor begins to covet the profits of the franchisees. The franchisor then begins to open company-owned locations. McDonalds is a great example. Ray Kroc expanded the company originally by offering franchise opportunities. According to Yahoo! Answers, in 2010 the company owned 6,399 stores versus 26,338 franchisee owned stores, which is close to 24%. The company also owns a lot of the real estate for the stores operated by its franchisees. As you can see, McDonalds drinks its own business model Kool Aid. If you are a franchisee, you might justifiably worry they'll drink your Kool Aid as well.

In my next post, I'll cover our experience in the accounting software industry over the past twenty years and how we reacted to a vendor, who coveted our cash flow. I will also cover how to know when the marriage to your non-equity partner is over and hopefully some ways you can live the single life after the divorce.

Don't forget the Free Frank Rally to be held at the Lost Rhino brewery in Ashburn on Wednesday, September 5^th(www.lostrhino.com). We are protesting my wife's censorship of this blog. I will try to get her to attend so that you can express your displeasure directly to her. You can support first amendment rights while drinking beer. The founding fathers would have been proud, particularly that lush, Ben Franklin. This sure beats dumping tea in the sea.

Thanks for reading. As always, please visit our main S&K web site at www.skcpas.com.