What Business Is Your Franchisor In?
During my tenure as the General Counsel of the National Coalition, I have often wondered how best to characterize our franchisor. Is 7-Eleven, Inc. a convenience store retailer and franchisor? A gasoline provider? A logistics and supply company? An accounting and bookkeeping company?
Increasingly, the answer seems to be that SEI is well on its way to being best characterized as a gasoline company, taking into consideration both its retail and wholesale gasoline operations. The most recent chapter in this book is the April 6, 2017 announcement that SEI’s parent company would purchase 1,130 Sunoco gas stations and convenience stores for $3.3 billion, with the transaction anticipated to close in August 2017. This transaction follows a much smaller one in June 2016, which involved the purchase of 79 gas stations and convenience stores in California and Wyoming from CST brands.
Before that, SEI engaged in five additional gasoline-related acquisitions, including a December 2011 transaction with Exxon Mobil involving 183 gasoline properties, a December 2013 acquisition of 145 gasoline stores and a wholesale gasoline business, a January 2016 transaction with Biscayne Petroleum involving 94 retail properties and 7 supply contracts, and a May 2016 acquisition from Harbor Petroleum involving wholesale fuel contracts.
By our calculation, SEI has engaged in acquisitions involving more than $6 billion during the period 2013 to date. By contrast, over the last three years, the company has spent less than $340 million on capital improvements to existing corporate and franchised stores, not including $54 million on gasoline tanks. To put it another way, the company is willing to spend handsomely to increase its portfolio of gasoline assets, both wholesale and retail, but only willing to spend pennies by comparison on fixtures, equipment and remodeling and refurbishment of its franchised convenience stores.
The dominance of the gasoline component of SEI’s financial condition is exemplified by the fact that from 2010 to 2015, its gross margin on the sale of gasoline increased by 94 percent; but over the same period of time, franchised in-store merchandise gross margin increased by only 49 percent, or half that rate. In 2015, for the first time, the gross margin contribution from gasoline exceeded that of the in-store merchandise gross margin contribution from company stores.
While 2016 financial statements are not yet available to us, the parent company reports that in 2016 41.4 percent of SEI sales came from gasoline. With the Sunoco acquisition, that will certainly soar. In a similar vein, after the Sunoco acquisition, we estimate that 44.3 percent of all the 7-Eleven locations in the United States will be gasoline stores.
We can also report that SEI’s total revenue fell by 21 percent from 2013 to 2015, driven primarily by a decline in fuel sales of 28 percent over the same period of time, driven, in turn, by lower oil prices. However, from 2013 to 2015, SEI’s gross margin on fuel sales rose by nearly $30 million. Quite obviously, the only way the company could have realized higher profit on lower sales was to raise prices at the pump, to the detriment of convenience store sales at gasoline stores. The end result was increases in SEI net income ranging from about 8 percent to 10 percent per year, driven primarily, one could argue almost exclusively, by the profit generated from the gasoline business.
What’s driving the strategic decisions?
Because SEI and its parent company keep its strategies as close to the vest as possible, we are constantly forced to play detective and make reasonable deductions based on the evidence available to us. Here are my thoughts.
First, the parent company of SEI has had more than its share of troubles, with boardroom battles, a major wage and hour scandal in Australia, and a stock that substantially underperforms the Nikkei Index and the S&P 500. Its supermarkets and department stores have been losing money. The only segment that has shown growth and profitability is the convenience store business. It needs yet more sources of profit, and SEI’s parent is willing to spend a lot of capital to get it. Thus, the planned expansion in the U.S. with the goal of reaching 10,000 outlets by 2019.
Second, gasoline and gasoline pumps are not like franchisees. They don’t organize into franchise owners’ associations. They don’t have a website, or an advertising supported publication or develop independent, mutually beneficial relationships with their vendors. They don’t hire lawyers and other professionals to protect their interests. They don’t need to be invited to sit on committees and they don’t talk back; in fact, they don’t care if you talk to them or not.
Third, the gasoline business provides a source of increasing gross margin contributions, in the face of declining merchandise gross margins in franchised stores and in company stores over the last five years. Gasoline is a business segment where SEI controls the retail price, often to the detriment of the franchisee. Over the last four years, SEI’s gross margin on gasoline has vastly outpaced company convenience store gross margin and franchisee gross margin. That makes it less painful for SEI to sacrifice in-store sales in favor of profit at the pump in its gasoline stores, which after the Sunoco acquisition will reach almost 1/2 of all stores in the United States.
Fourth, the Sunoco acquisition may signal an even deeper incursion into the introduction of the fast food format into the 7-Eleven franchise system. As reported by the Dallas Morning News: “7-Eleven, which has been building its fresh food offerings in recent years, is gaining a whole new menu of breakfast and lunch tacos with Laredo Taco Company and Stripes. A new Stripes store in Corpus Christie has a dining area with 28 seats and an outdoor patio for 20 more, which is different from the traditional 2,500-square-foot 7-Eleven.” This should be troubling news to franchisees. Given that SEI has been repeatedly asked for evidence of the incremental labor costs and incremental net profit from fresh food and hot food, to no avail, franchisees should be very wary of the company’s inattention to their bottom line.
This flies in the face of Cheryl Bachelder’s theory of the management of a franchise company, which is centered on unit level profitability. See www.https://hbr.org/2016/10/the-ceo-of-popeyes-on-treating-franchisees-as-the-most-important-customers. Her servant leadership model led to a remarkable turnaround at Popeyes and its recent sale to the parent company of Burger King for $1.8 billion. The management of SEI, which has been seeking a liquidity event for years: please take notice. Cheryl Bachelder is not some bleeding heart liberal. She is a hardheaded, supremely competent business manager who figured out that the best way for a franchisor to succeed is to have successful and profitable franchisees who vote with their checkbooks by buying more and more locations in the system.
Fifth, part of the deal with Sunoco is a 15-year supply agreement under which SEI will purchase 2.2 billion gallons of gasoline per year. Although not disclosed, we have to wonder whether favorable or at least controlled pricing to SEI is part of that arrangement. This will allow SEI to continue to grow its gross profit margin on gasoline with the consequences to franchisees noted above.
As we’ve stated in the past, these are very crucial times in the business life of every 7-Eleven franchisee. This is also an existential moment in the 40-year history of the National Coalition. It is vitally important now, more so than it has been in at least the last 15 years, that the National Coalition, every FOA and every franchisee be focused laser-like on a single and solitary goal: achieving a fair and balanced 2019 franchise agreement, which is the product of transparent, good faith collaborative negotiation, and which allows every franchisees to attain a fair reward for their investment and hard work on behalf of the brand.