FRANCHISES

Head of the Class

Start-up company franchises early childhood education centers, targeting affluent parents.
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Will parents pay more for day care if the centers are positioned as schools?

Nothing in business is quite so powerful as a demographic wave read correctly. The wave Joseph Scandone wants to ride -- the entrance of mothers into the labor force -- is still far from cresting. About 56% of all women with children under age six were working in 1988, up from 25% in 1965. Liz Claiborne read it right. So did Kinder-Care. Reebok, too.

And now, so has Joe Scandone -- or so he thinks.

Almost two years ago Scandone started Carousel Systems Inc., a day-care company based in the Philadelphia suburb of King of Prussia, Pa. He plans to build a network to compete with industry leaders Kinder-Care Learning Centers Inc. and La Petite Academy Inc., which run 1,253 and 700 child-care centers, respectively. An old idea, perhaps, but Scandone feels he has a new twist, a second play on the demographic wave that the established companies have ignored.

When Kinder-Care started in 1969, says Scandone, it "developed a product for the emerging working woman who, until then, left her kids with somebody she knew. The mother was a low-level service worker who just needed a place to drop her kids off. Kinder-Care and the other companies that followed delivered safe, secure, sometimes loving care with a hot lunch."

But a good number of today's working mothers, says Scandone, are different, and the existing chains don't serve their needs. They hold high-paying managerial or professional jobs, want less baby-sitting and more emphasis on education, and are willing to pay a premium for it. Though the established chains have responded with educational curricula, Scandone calls these changes little more than window dressing. "We found that parents are looking for nursery-school quality," he says.

Scandone saw that there was plenty of room to maneuver within the industry. Day care remains essentially a mom-and-pop business ringing up annual sales of about $15 billion. Although the national chains grew 200% during the 1980s, they still accounted for only 5% of all child-care centers operating nationwide. Last year only nine chains had as many as 24 centers. The rest were much smaller operations, many of them nonprofit, or run in a provider's home.

Scandone's response is a second-generation child-care company. "We're taking a nursery-school program and fitting it between day-care hours," he says. For Carousel, whose units will operate under the name Goddard School for Early Childhood Education, the major departure from traditional child care will be the hiring of teachers certified in elementary education or early childhood development. Goddard Centers will be licensed by the state not only as child-care centers but also as educational facilities, an unusual status in the industry.

Scandone will charge 10% to 15% more than the national chains, or up to $1,000 more per year in big-city markets. He is targeting affluent parents who might otherwise choose independent centers or a Kinder-Care. "We'll take the cream from the national chains," he predicts.

The other big departure from the norm is that the Goddard Centers will be owned not by a faraway corporate parent, but by franchisees. Parents will be greeted at the door by an owner whose livelihood depends on their satisfaction, not by a manager dispatched from company headquarters. "Parents will feel, touch, and see that Goddard schools are different," promises Scandone.

* * *

A long driveway leads to the front door of a stone Cape Cod-style house in Malvern, Pa. It is, like many houses in this affluent Philadelphia suburb, set on a wooded lot blanketed now by snow. A discreet sign outside carries the Goddard name.

Inside the front door is a brown horse that once rode on a carnival carousel. Nearby are the children's cubbyhole mailboxes, filled with handwritten notes from teachers to parents explaining that day's lessons. Kids in one room are singing Christmas carols as their parents listen; in another, a teacher named Jennifer is preparing a midmorning snack. "Whoever is quiet will get their snack first," she announces, and a hush falls over the assembled.

This is the first of Joe Scandone's two child-care centers, and the model on which the franchised centers will be based. Each week, every class in the center focuses on the same subject -- in March, for instance, they'll learn about weather one week, pets another, dinosaurs a third. Each teacher formulates his or her own lesson plan appropriate for the age group, designed to advance four important developmental skills: cognitive, physical, social, and emotional.

Scandone's purchase of the center in 1986 was no attempt to pursue a lifelong passion for child care. He was simply looking for a business to run. He had spent 12 years at the General Accounting Office reviewing a variety of federal initiatives such as Head Start, the early-education program. Then he served for 6 years at General Electric Co.

In 1986 Scandone quit G.E. and began analyzing various business opportunities. The demographic changes that gave rise to the child-care business intrigued him, as did the fragmented nature of the industry. Might there be room for another national chain? By the time he had opened two centers two years later, he had become excited about building a national company. But he didn't know how to do it.

For advice, Scandone sought out Tony Martino, for whom he had worked more than 20 years earlier, when he was a high-school student. Martino had distinguished himself by building three major franchise businesses. In the 1960s he had grown AAMCO into a network of more than 500 transmission-repair shops, with sales of some $100 million. Martino had sold AAMCO and founded MAACO Enterprises, now a chain of 450 shops that specialize in painting and collision work. And he did it a third time in the 1980s, growing SPARKS into a string of auto tune-up centers before selling it.

Martino liked the child-care idea so much that he offered to help Scandone franchise the business. It is, after all, one of the fastest ways to build a national company. And speed mattered. Scandone felt certain that if he did not move quickly, competitors -- perhaps the big chains themselves -- would vault past him. So Scandone and Martino started the company in 1988, the latter providing virtually all of the $250,000 capitalization and taking a majority of the stock.

Franchising does pose some difficult challenges, though. It has never worked in the child-care industry. Kinder-Care had tried franchising when the company started in the late 1960s but had given up and switched to company-owned centers. Other day-care franchisors had shut down or followed Kinder-Care's route.

All these operations had one problem in common -- the inability to control the quality of service delivered by the franchisees. It is difficult enough to control a franchised MAACO shop, where the procedures are relatively amenable to lists in an operations manual. But dealing with kids means a wild card every minute, more than a match for anyone who would distill a day's activities into a neat routine.

Scandone and Martino, however, argue that franchising is the biggest advantage they have for delivering quality child care. They dismiss the failed attempts by saying that, until now, nobody brought to child-care franchising the kind of track record they do. More than that, though, they believe local ownership will make the difference. "Quality control might be a big problem," says Martino, "but it won't be one-tenth of what you'd experience from a company-owned location. Quality is inherent in the fact that the owner is there. An owner will always do a better job than a manager.

"Remember that a manager is on a career path, and you rarely find one who says, This is the top, I've arrived. We turn over managers all the time at the MAACO shops. But the owner will be there a long time. His view is longer." If an owner allows quality to slip, Martino promises he will move quickly to revoke the franchise.

Quality control, the founders point out, will be a primary responsibility of the local operations manager, who will work with 10 or so franchisees and visit their facilities once or twice a month. Having a large staff of teachers will be another quality check, since they are likely to be sensitive to any shortcuts a franchisee takes in the educational and developmental program. Those teachers also will be, Scandone hopes, Goddard's most persuasive selling point.

* * *

Even if Scandone has correctly perceived that parents want more education from child care in the 1990s, he still must effectively market his idea. Because he's franchising, he must worry about two groups of customers. One is made up of prospective franchisees. What will he offer them that is worth a substantial franchise fee and royalty? But perhaps the most important group of customers is the parents themselves. Will they see a clear difference in quality in the new centers?

As any working person knows, good child care is expensive. The cost varies with the age of the child -- typically it's highest for infants -- and by region of the country. What costs $330 a month for a toddler in Boulder, Colo., can cost $730 in Boston. By pricing his service 10% to 15% higher than his competitors, Scandone is aiming for an upper-middle-class customer in a major metropolitan area who can afford to spend an extra $500 to $1,000 per child each year. For the most part, that means families with incomes above $50,000.

Scandone says they're an underserved part of the market. When he analyzes a potential site, he uses census data to analyze the demographics within a five-mile radius, looking at such variables as family income, the number of working mothers, and the number of children under age six. Then he counts the spaces available in local child-care centers; usually, he says, there is plenty of room for another provider.

It's unclear, though, how many of these affluent parents he'll be able to corral. Less than one family in four earns $50,000 or more, and many of these are overburdened already by mortgage and credit-card debt. Others have more than one child, which would multiply the cost of switching to a more expensive provider like Carousel.

Scandone, then, faces a difficult marketing challenge -- reaching potential customers with a message that Carousel is clearly different. He is confident he can do this by using the usual media -- radio, newspapers, and the Yellow Pages -- to drive home the theme of education and childhood development. If the ads and word of mouth bring in parents for a look, he says, a tour of the facility will sell it to them.

"What we're charging extra for is visible and identifiable," says Scandone. "By seeing the number of teachers we have in the schools, they'll know what distinguishes us." Customers, he says, were not difficult to recruit in his own two centers. "I haven't met any price resistance, and my own schools are 12% to 15% higher than the competition."

If the franchisees can indeed attract customers, Scandone's projections demonstrate that the higher fees will bring them some huge margins. Each center should reach break-even in its first year, he says. By the end of its second year (see "Financials," page 4), it should be enjoying gross margins of about 21% by filling 80% of its seats. That would be two to three times the margins of the industry as a whole and of its two leaders, Kinder-Care and La Petite Academy.

If that sounds optimistic, Scandone points out that his own two child-care centers see gross margins in the high 20s. Reaching those lofty heights requires the kind of leveraging that represents the heart of his concept. Salaries in the child-care industry are dismally low. By offering 15% more in total compensation than his competitors -- but still only about $15,000 a year -- he says he can attract certified teachers and thereby position his service as an educational and developmental center. The $30,000 in resulting payroll expense should bring in up to $70,000 in additional tuition revenue, Scandone figures -- actually more, he adds, because the emphasis on education will also enable franchisees to fill a higher proportion of their licensed spaces.

Another key to profitability will be the efficiency of each franchised center. This doesn't mean saving money by making a smart buy on red crayons and construction paper; it means running full classes for as much of each day as possible. Most states set teacher/student ratios -- say, one adult for every 8 preschoolers. So centers that routinely get a multiple of 8 toddlers are very efficient; those that bring in 18 kids require a third adult to look after only 2 children -- and profitability suffers.

Juggling children to fill each class to capacity is one of the toughest parts of the business, but Scandone thinks franchisees have more incentive to do it well than managers in a national chain. "It goes right into their pocket," he says.

Scandone encourages franchisees to fill open slots with part-timers and after-school children up to the age of 10. Since these kids bring in a premium of about 25% per hour over the tuition of full-time kids, filling one spot with two half-timers can deliver 125% of the expected revenue for that space. Skillful scheduling of after-school children, he says, should produce extra revenues of $42,000 a year, or about a third of gross profit.

* * *

The ideal franchisee, says Scandone, is someone with business acumen who has no prior experience in the industry. Scandone wants franchisees to follow his system to the letter, and he fears that experienced child-care providers would be difficult to control and eventually would graft too many of their own ideas onto his model, producing a hybrid that compromises the image he wants to project. So among the first people to sign franchise agreements were an engineer, an insurance executive, a computer company vice-president, a real-estate developer, and a supermarket retail manager. "What I'm looking for," says Scandone, "is someone who's worked in a corporate environment and supervised people."

The initial investment for a 122-child center is about $140,000, of which $25,000 is a franchise fee paid to Carousel. The royalty is 8% of gross revenues, discounted to 7% if payment is timely.

The fee and royalty seem relatively steep for the child-care business. Profit margins are very thin, an average of less than 5% on an aftertax basis. Unless the Goddard centers are far more profitable than the average, the royalty could drain the bottom line of each franchisee. To sell the franchises, then, Scandone must show that Carousel's support will make the centers much more successful than they would be on their own.

In Scandone's system, the franchise owner runs the business end of the operation and delegates responsibility over the educational program to the center director, a certified teacher. Most child-care centers combine these responsibilities in one job. The teaching program itself, detailed in an operations manual, was designed by one of Scandone's staff, Suzanne duPont, and consultant Fran Ritter, director of the child life department at The Children's Hospital of Philadelphia.

Aside from the curriculum, Scandone points to services that he says more than justify the fees and royalties. Carousel helps franchisees secure financing and assists them in identifying a promising site for a center. It provides support in recruiting, advertising, and public relations. For instance, last fall the company helped one franchisee place a children's playhouse and information desk in a local mall as a way of spreading the word among parents.

Carousel puts new franchise owners through two weeks of intensive training in all phases of the business. Once centers are open, Carousel will have operations people in the field to provide ongoing support.

Bud Gosnell, a 51-year-old engineer who in January became the first franchisee to open, says he couldn't have started without Carousel's help. "I'd have had to design the facility, get a curriculum, start from scratch," he says. "I don't have the savvy for that. They're already in the business, and that gives me a shortcut. They'll teach me how to run it."

Like other franchisees, Gosnell had heard about Carousel through a newspaper advertisement. In the future, a Carousel salesperson will work with interested people, guiding them through the process of approvals and signings. Scandone figures an average salesperson, after a six-month break-in period, will handle about 15 franchise sales a year, which he says will continue to be generated by ads and word of mouth. The marketing tool that will clinch the sale, he says, will be a tour of one of the Goddard centers, where thoughts about pro forma projections will dissolve into pleasant images of running a business for kids.

Successful sales and openings could produce attractive returns for Carousel. Scandone's pro forma projects profitability this year, Carousel's second full year of operations. It won't be until 1993 that the royalty fees will begin to produce significantly more revenue than the franchise fees; Scandone predicts operating profit of $2.7 million on revenues of $11.8 million that year. Scandone has a big incentive for moving the revenues up quickly; under his agreement with cofounder Tony Martino, he receives a bonus each year that is 12.5% of the royalty fees.

On the expense side, Scandone enjoys a major advantage from his association with Martino. He runs Carousel from the MAACO headquarters and receives its franchising support services -- probably of higher quality than he could get on the outside -- essentially at cost. This subcontracting also enables him to run a very lean shop; even now, Carousel's payroll includes only three people other than Scandone.

He also plans to hold down expenses by carefully directing the company's growth. Instead of opening centers wherever potential owners show interest, he'll grow the company in geographical clusters of about 10 centers each. That way, he says, he can deliver a high level of support with only one operations person in the field assigned to each cluster.

The first cluster will be in the Philadelphia area, the second in suburban Washington, D.C. Two centers opened in January, and Scandone expects to have 15 operating by the end of this year -- 65 by the end of 1991. Then he expects the pace to quicken even more, with 240 units in operation in 1993.

That's the kind of pace that only Kinder-Care and La Petite Academy have been able to sustain until now. It certainly places into sharper relief the central questions about Scandone's business. Can he maintain a high standard of quality in a franchised operation that is growing quickly? Can he differentiate Carousel from its competition? Will parents be willing to pay an extra $500 or more for his service?

"I'm not the first guy to deliver quality and charge more for it," he says. "If the perceived quality is there, people will pay for it."

* * *

Research assistance provided by Leslie Brokaw.


FINANCIALS

Franchisee Projected Annual Operating Statement (Goddard School for Early Childhood Education)

REVENUE

Tuition: infants (15 @ $6,240/ year) $93,600

Tuition: toddlers (15 @ $5,640/year) 84,600

Tuition: preschoolers (68 @ $4,500/year) 306,000

Tuition: part-time differential

(25% premium over full-time) 42,368

Registration fees 3,430

Total gross revenue $529,998

OPERATING EXPENSES

Franchise royalty (7% gross revenue) $37,100

Taxes and payroll expenses (for director,

5.578 teachers, and 7.971 aides; franchisee/

operator receives no salary) 213,523*

Rent 91,000

Advertising & Yellow Pages listing 22,400

Phone, utilities, & building maintenance 20,400

Insurance & professional fees 9,508

Supplies, snacks, contingencies &

miscellaneous 23,495

TOTAL OPERATING EXPENSES $417,426

GROSS PROFIT

(before taxes and interest expenses) $112,572

*Salaries will vary depending on city of operation

CAROUSEL SYSTEMS (FRANCHISOR)
PROJECTED PROFIT & LOSS
1990 1993
Revenue ($millions) 1.65 11.75

Net Profit ($millions) .17 2.65

# of centers 15 240


EXECUTIVE SUMMARY

THE COMPANY: Carousel Systems Inc., King of Prussia, Pa.; franchisor, Goddard School for Early Childhood Education


CONCEPT:
Create a national chain of franchised day-care centers targeting upper-income parents who want more formal education for their children

PROJECTIONS: Franchisor operating profits of $170,000 this year and, in 1993, profits of $2.65 million on $11.75 million in royalty and franchise fees from 240 centers; franchisee gross profits of $113,000 on revenues of $530,000 (21% margin)

HURDLES: Meeting high margin projections at each center; maintaining quality while aggressively expanding; differentiating Goddard enough to support premium pricing


THE FOUNDER

Joseph Scandone, president and CEO

Carousel Systems Inc.

Age: 41

Family status: Married, two daughters, 16 and 18

Workweek: 50 to 60 hours

Board of directors: None

Other businesses started: Two child-care centers in the suburbs of Philadelphia

Last job: Manager of human-resources operations, General Electric Information Services Co., a division of G.E.

College degree: B.S. with major in accounting from Philadelphia College of Textiles & Science; executive degree from Wharton School at University of Pennsylvania

Loses sleep over: The inconsistencies of local officials in approving child-care centers, which cause facility-opening delays beyond Scandone's control

Role model: Lee Iaccoca; "He's very customer oriented."

Vacations: Stays at houses he owns in Ocean City, N.J., and West Palm Beach, Fla.


WHAT THE EXPERTS SAY

OBSERVER

DICK RICHARDS

President, Childcare Center Brokerage & Development, St. Louis, which develops and brokers centers for the nation's largest day-care chains; former director of real estate for Kinder-Care

I agree that small centers can operate at greater margins than national chains, as long as the operators are qualified. But it's really presumptuous to think franchisees can attend a two-week training program and then be qualified to operate a child-care center. They should be brought into existing operations as interns, be given a longer orientation period, and be evaluated themselves by Carousel. If I were Scandone, putting together a high-end operation, I'd want to be convinced that the people I put out there know the industry inside and out. If you're selling this as the crème de la crème, you'll need to market it on the qualifications of the staff. And informed parents care less about the appearance of the place than they do about the philosophies and values of the operators.

If I were Scandone I'd set more realistic objectives: 5 centers this year, 10 next year, maybe 10 more after that, once my management was in place. There's a danger in trying to be the next Kinder-Care -- inadequate management leads to inadequate care, and parents pick up on it real fast, leaving you with empty centers. If they grow more conservatively, they can be successful. It'll be interesting to watch, because of their franchising experience.

FINANCIER

MICHAEL J. CONNELLY

President, Lepercq Capital Management, New York City, managers of a $32-million venture fund that has invested in child-care centers

It's true that this will continue to be a fast-growing business, there aren't any dominant players, and the market they're going after is the most attractive one -- the higher end, people who are looking for something other than custodial care. But their notion that they can do the rollout as quickly as they're planning and be able to make the margins they're projecting as consistently as they say just isn't realistic, even if they can do it with a few centers.

I feel confident saying no company in the history of the child-care industry has done what these guys are projecting. They expect franchisees to reach break-even in 12 months -- in practice it usually takes 18 to 36 months, and that's for centers that don't have to take 7% off the top just to pay a franchise royalty.

Then there's quality control. Scandone is going to take people who have no experience in early-childhood education and turn them into owners of early-childhood-education businesses. He's going to try to do it at the highest end of the market, with the most sophisticated clientele. One of the requirements of a developmentally appropriate curriculum for early childhood is flexibility. The criticism, for example, that's leveled at Kinder-Care by the educational community is not that it is custodial. The criticism is that they've McDonaldized the curriculum, so that if it's the third Tuesday in March, three-year-olds all over the country learn the letter C. That's perceived by the educational community as being an inappropriate way to develop the cognitive skills of three-year-olds.

This is not a commodity business; child care is as far from a commodity business as you can get. And it's very difficult to maintain quality, especially when you're franchising with people who've never done it before. Scandone says that he'll pull a franchisee if someone is not providing the level of quality that he insists on; well, how's he going to know? How's he going to measure it? If you do a bad job on transmissions, people's cars break down and they have to get towed in, and it's an expense -- but it's just money. You do a bad job on child care, you're risking a whole lot more than money. I don't believe the sophisticated market he's going after will be comfortable leaving its children in the care of people with so little experience. I just don't think it'll work.

COMPETITOR

ROGER BROWN

Chief executive officer, Bright Horizons Children's Centers, Cambridge, Mass., which developed and operates 26 work-site child-care centers on the East Coast

I don't know that franchising is going to work at the high end; it would be much more appropriate as a low-end strategy. Part of the reason involves teachers -- if you were a teacher, where would you rather work, a place that allows you to create your own curriculum, or a place that hands you a manual and says, "This week we're doing rabbits"? Hiring the best people is going to be difficult in this context.

If you want to do the high end, you ought to hire teachers who have a good background and give them autonomy. See, what they're touting is the fact that the entrepreneur-franchisee has financial autonomy in running the center, and that that's going to lead to better results than a company-managed center could get. But if you want to be on the high end educationally, you need to have that same autonomy in the educational program.

OBSERVER

ROGER NEUGEBAUER

Publisher and editor, Child Care Information Exchange, Redmond, Wash., an industry trade publication

The Carousel people present Kinder-Care as their main competition, and that's misleading. Their real competitors are the small chains with three to six centers that can be found in every community in the country. They run quality centers and charge a higher fee. They're after the same market Carousel is. Much of the growth in the past five years has been in this area, and now all the big chains are going after it, too.

There's nothing about franchising that prohibits it from working in child care, except the amount of the royalty. Average day-care profit margins are in the range of 5% to 6%. Even the yuppie centers are not dramatically above that. If you tell franchisees that the first 7% to 8% goes to the franchisor, that's not very encouraging. No chain over the past 10 years has been able to maintain profit levels above 15% for more than a few years; how is Carousel going to do it? Companies we've surveyed in the 8% to 10% profit range are already charging 15% more than their competitors, just as Carousel plans, so that premium alone isn't enough.

Last updated: Mar 1, 1990




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