Born-again Dealers

To solve marketing and distribution problems, a growing number of companies are converting their dealers into franchisees.

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Dahlberg Inc. wasn't exactly floundering in 1981, but it certainly wasn't flourishing, either. While sales of its hearing aids were up to $12.1 million from $9.3 million the year before, its net profit of $760,000 in 1980 had vanished.In its place was $644,000 worth of red ink. The company was headed in the wrong direction, for reasons that weren't readily apparent to Dahlberg's top managers. "It was frustrating because we knew the market had more potential," recalls K. Jeffrey Dahlberg, the 32-year-old president and son of founder Kenneth H. Dahlberg.

One possible explanation was inadequate distribution. At the time, the company's products were carried by only 2,000 of the nation's 7,000 hearing aid dealers. The logical solution was for Dahlberg's sales representatives to get the products into more stores.

But, five years later, most of the sales reps are gone, and there are fewer independent dealers carrying Dahlberg products than ever. Instead, the Golden Valley, Minn., company sells most of its hearing aids through 242 franchised Miracle-Ear Centers -- stores owned and operated by erstwhile independent dealers who have taken down their own signs to become Dahlberg franchisees. Earnings, meanwhile, have soared to $906,000 on sales of $31.1 million in 1985.

The technique is called "conversion franchising," and Dahlberg is one of a growing number of companies using it to solve their distribution and marketing problems. Others included Curtis Mathes Corp., the Dallas-based consumer-electronics firm; Four Seasons Solar Products Corp., a Farmingdale, N.Y., manufacturer of greenhouses and solariums; and Parson-Biship National Collections Inc., in Cincinnati.

It is an innovative strategy, based on a technique that's been around for years -- ever since the 1970s, when Century 21 Real Estate Corp. emerged as a national powerhouse by convincing independent real estate brokers to become its franchisees. Subsequently, the concept has been applied in many other service industries, ranging from accounting to insurance to home repair. These "traditional" conversion franchise operations are companies built, in effect, around existing channels of distribution. Only recently have companies, particularly manufacturers, turned the concept on its head -- using conversion franchising to build captive channels of distribution.

For Dahlberg and others, the technique has worked well, in part because it forces the companies to adopt a more disciplined approach to marketing, sales, and distribution. Under the old system, says Jeff Dahlberg, the company focused on adding more dealers to its network, rather than supporting the dealers it already had.It shied away from providing dealer-training programs and computer support systems for fear that they would be used to sell competitors' products as well. Furthermore, with 2,000 dealers, the cost of such programs was prohibitive. Now the company has 133 franchisees, which carry no competing products. That allows Dahlberg to concentrate on supporting its franchisees, rather than just adding new accounts.

"It comes down to marketing," says Dahlberg. "We couldn't effectively market our products before; we could only sell them. With franchising, we don't have to worry about selling, because [our franchisees] do it for us."

For the dealers (or, in some cases, the sales reps) who convert, the arrangement has obvious appeal. In exchange for giving up their status as independent businesses, they gain marketing clout never before available to them. Moreover, if the conversion suceeds, their businesses are likely to appreciate in value. "When I'm ready to sell my company," says Floyd Loupot, a Pasadena, Calif., Miracle-Ear franchisee who had operated his own hearing aid dealership for 20 years, "I believe it'll be worth more to a buyer."

Yet, for all of its potential benefits, conversion franchising can be a treacherous path for the unprepared and undercapitalized. Dahlberg's sales numbers look good, but they reveal only part of the story. The company lost $759,000 in 1984, its first full year of franchising. Selling and administrative expenses ballooned from $4.6 million in 1982, when it began developing the franchise, to $11.6 million in 1984. In addition, Jeff Dahlberg points out, there is the "mind-boggling" cost of management time devoted to the conversion. Beyond all of those costs lies a new reality that comes with the change: Dahlberg, once just a manufacturer, is now in the franchise business as well. To succeed at both, it has had to hire people with experience in franchising, real estate, training, and information systems.

If a conversion works, however, the system serves to bind valuable people to the business and gives them enormous incentive to perform. Parson-Bishop National Collections started granting franchises early this year to its 12 regional sales reps. Over the years, some had asked for equity, but company president Lou Bishop was reluctant to part with it. "Franchising was the best way to solve the problem," Bishop says. The franchise agreement guarantees the reps a protected territory. The franchises can be sold at a later date, too. "Suddenly, I have a highly motivated team of franchisees out there without giving up very much of my company," he adds.

That, indeed, is a major reason for making such a switch. In theory, at least, the franchise format encourages a higher degree of involvement and commitment than a dealership or a sales agreement, because each franchisee has a personal stake in building the franchisor's business. "Our dealers [who became franchisees] have made a real commitment to our products," says Chris Esposito, president of Four Seasons Solar Products, which launched its conversion program in 1985. "They've built showrooms. They've hired people to sell.Before, I was always trying to get that from them, with only spotty success."

Of course, to gain such commitment from franchisees, a franchisor has to make a commitment of its own, in the form of national advertising, training programs, and dealer-support services. Such programs are expensive -- beyond the means of most small manufacturers. The beauty of the franchise format is that it allows the manufacturer to share the cost with franchisees. Under most franchise agreements, franchisees pay a royalty based on gross sales. Dahlberg uses a different system, charging franchisees a flat rate of $31.50 for every product sold, as well as $15 for each lead generated in their territory by a national ad campaign. Dealers are allowed to set their own prices on products and pay no franchise fee on service revenues.

Dahlberg developed its system during a two-year period leading up to the actual conversion. The first step of that process involved the opening of a pilot retail unit in Minneapolis late in 1981. The store was patterned after an optical shop, on the theory that the hearing aid business -- with dozens of small manufacturers and thousands of independent dealers -- had reached a stage similar to that of the eyeglass industry more than 20 years before. Dahlberg hoped to outflank its competitors with a more focused marketing strategy. The risk was that, instead, it might plunge its distribution and sales into chaos.

The goal of the pilot project was to gain experience. "As manufacturers, we really had to learn the retailing business for the first time," Jeff Dahlberg says. Toward that end, the company tired out various advertising and promotion programs to see how consumers would respond. It also experimented with new management methods -- testing training programs, for example, and hiring salespeople as employees with benefits, instead of independent contractors, as is common in the industry. (Today, its franchisees do the same thing, getting group discounts on health insurance.)

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