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Alternate Channels Can Kill Franchisees

What do Warren Buffett and Carvel have in common?

If you thought of Buffett's ownership of Dairy Queen and answered "ice cream", you are only partially correct.

In addition to the DQ franchise, Berkshire Hathaway (NYSE: BRK) also distributes Benjamin Moore Paints. Much like Carvel franchisees did 30 years ago, the dealers of Benjamin Moore now face a dark future due to alternative channels of distribution.

Benjamin MooreIn the case of Carvel, the culprit was changing consumer habits that favored buying ice cream at the supermarket instead of the local mom-and-pop store. In the case of Benjamin Moore, the culprit is the rise of the big-box home improvement store.

This is one area where zors can have interests diametrically opposed to zees: the zor wants to follow the retail consumer, but the new distribution channel cannibalizes the existing zees.

Having spent a billion dollars to buy Benjamin Moore a decade ago, BRK arguably has an obligation to extract maximum value for shareholders of BRK, and that path leads thru the mega-stores now favored by consumers.

Recent months have seen allegations in the press and in court that BRK cut credit lines to Benjamin Moore dealers and squandered advertising monies, in addition to targeting wholesale accounts to switch from the dealers to Benjamin Moore corporate.

Franchisees/Dealers often assume that they are in a quasi-"partnership" with their franchisor/distributor and that sales growth will benefit them both. This false assumption has sent more than a few zees down the road to financial ruin.

The examples of Carvel and Benjamin Moore are less frequent than cases involving online channels of distribution, and are much more difficult to resolve since the use of alternate retailers (supermarkets or big box stores) necessarily comes at the expense of the existing distribution relationship. Unlike internet sales where some type of "reverse royalty" is feasible, the distribution thru narrow-margin big box retailers often does not leave sufficient profit to compensate the original (franchisee) channel.

Time will tell how the Benjamin Moore dealers fare, but history does not give reason for optimism.

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