Wayne Wants To Be Like Mike
by Richard L. Narva
I can just hear the Wayne (Huizinga) wannabes at the Wall Street Deli,”Gimme a family business roll-up, and hold the family.”
Remember Wall Streeters in the ’80’s with its prodigious appetite for junk.The progeny of the Barbarians at the Gate have discovered a new feeding frenzy:Rolling up family businesses in industries with no dominant player, and paying for the market share created by entrepreneurial families with publicly traded securities instead of cash.
Fortunately for these Wayne wannabes, there seems no shortage of investors with an appetite for roll-ups.And the business media glorifies the “Rollers-up” with paeans heretofore reserved for Mike Millken and the junkers of Drexel prior to Millken’s incarceration. Commentators praise the consolidators for replacing the economic detritus of emotionally laden, erratic performing family firms with the clarity of business plan driven, SEC compliant issuers of public equities for voracious investors.As usual, the media have it half right.
As in the Golden era of junk bond excess, the rolling up of American family businesses presents the scenario of a basically sound idea submerged in an ocean of too much money chasing too few good deals.Greed overwhelms analysis.Due diligence discipline resembles weight watchers during the Christmas holiday party season.And a good many operating companies and their constituencies suffer the consequences.Before the rolling up of American family business gets too far out of hand, it is appropriate to examine why so many industries dominated by family business attract the attention of the Rollers-up, why roll ups unlock shareholder value, and why–in the long run–the consolidating companies may not be worthy of investor confidence.
Dirk Dreux, a leading analyst of the family business market, once observed a fundamental, but often overlooked reality about the American economy.Fortune 500 companies manufacture the goods Americans and American companies buy, but it is family businesses that sell them through the distributors, dealerships and franchises they operate.Ford does not sell cars to drivers, nor Anheiser Busch its beer to football fans, nor McDonald’s its burgers and fries to kids.They sell them mostly to family businesses who sell them to us.
The difficult tasks of providing customers service and support, of managing relationships and understanding the ever changing markets for the products of Fortune 500 manufacturers are responsibilities historically borne by family controlled business enterprises.It is true that technology generally and the Internet in particular are generating fundamental changes (direct seller Dell Computer now holds second place in the market for PC’s and some observers estimate that nearly one quarter of all auto purchases are investigated or concluded over the world wide web).But clearly, for the foreseeable future, dealers, distributors and franchisees will remain necessary distribution channels for most manufacturers.
The consolidators know this reality and act on it, garnering market share by acquisition, slashing costs by centralizing functions and overhauling outmoded logistics and management information systems.These actions create short term profit increases and prop up the shares of the consolidators’ publicly traded securities.But the acquisition habit, like the new store opening habit of many retail companies, produces growth rates that are seriously misleading.
Retail stock analysts long ago learned that it is the comparative year to year data for stores open more than one year that provide the only meaningful insight into retail company performance.By the same token, after the short term cost cutting benefits are harvested by the consolidators, what long term value do they offer to the customers in markets where competitors are now few and far between?How does one measure whether roll ups are strategic initiatives or merely grand tactical measures producing rapidly depleting benefits?
In my view, once the initial flush of cost savings generated by installing conventional economies of scale are past, consolidators are remitted to eating their seed corn.Their gambit is essentially toharvest the goodwill and relationship equity that smaller, family controlled enterprises have developed with their customers over long periods of time.This historic relationship equity and good will is manifested in the higher than average gross margins that many family controlled companies are able to maintain(Or alternatively, these higher than industry average margins fund the quality of service and customer relationships that are the hallmark of these successful family firms).
Harvesting on the scale and with the speed consolidators undertake would not be so pernicious if the consolidators had a successful track record of conceiving and operationalizing strategies to maintain this goodwill and relationship equity.In my view it is almost always the culture and the values of the founding family that undergirds the constant commitment to customer service and relationships, and since this off balance sheet asset rarely survives a roll-up, what does the consolidator offer in its place?
One does not need to cite Aaron Feuerstein and the sterling story of Malden Mills to make the point that many family businesses can be world class competitors without relinquishing their independence and the core values by which they have been governed for decades or generations.A careful study of the paradigm companies in the classic study by James Collins and Jerry Porras, Built to Last:Successful Habits of Visionary Companies, demonstrates that nearly half of the eighteen paradigm companies selected by the authors either remain family controlled or were family controlled for at least two generations.
Collins and Porras provide a cogent, research based case for the premise that faithful adherence to core values that do not begin and end with short term profit enhancement distinguish America’s most successful companies.If in doubt, ask Warren Buffett.
The folks at the Wall Street Deli will be ordering family business roll ups (and be sure to hold the family) for some years to come, because the short term profits are clearly available for harvest, and because many manufacturers see them as willingaiders and abetters of their own strategies to rationalize obsolete distribution systems.Consider for example how helpful Wayne Huizinga is to General Motors’ Project 2000 program to consolidate its distributorship.
But my guess is that in many instances it will be the family controlled distribution companies who will decide when and where to roll up their own industries.In these industries, such as alcoholic beverage distribution, the shoe is already on the other foot, and the global manufacturers such as Seagrams are now dependent on as few as two full line distributors in many states, and no longer have anywhere else to go to have their products reach the consumer.
For my investment dollar these are the companies where I would place my long term investment capital.But I can’t because they will remain family controlled and private.And this infuriates Wall Street.