Culligan Franchise Pact Could Become a Model

Dismayed, the dealers called an emergency meeting in Dallas in May of last year, where they made a fateful decision: If they couldn't get their new franchiser to make significant concessions, they would leave the system, en masse, and start their own rival company.

The Wall Street Journal Online
February 22, 2007

Culligan Franchise Pact Could Become a Model
Richard Gibson

Dealers of Culligan water-treatment products didn't take the news well when in 2004 they learned that the franchiser was changing hands once again.

Over the years, Culligan had become an itinerant brand, shuffled among so many owners — 11 since 1978 — that it was hard to remember them all.

Then something remarkable happened — at least as far as franchising is concerned.

It wasn't quite water running uphill, but Culligan's new owner, a Wall Street private-equity firm, realized that relations with the dealers had deteriorated badly. Having hundreds of antagonists out there would put its $610 million investment at risk, so improvement in relations was vital. At the same time, though, the new owner didn't want to cede too much to franchisees for fear that conflicts over how the business should be run could seriously damage the enterprise.

The result was what some negotiators called a "gut-wrenching" process of give-and-take between the two sides, capped by a daring ploy by Culligan's dealers, that eventually produced what some think could become a model contract for other franchise businesses.

The new franchise agreement represents shared commitments, responsibilities and rewards. Dealers who previously had little clout — something common in many franchising systems — now play a critical role in decision making. Besides being consulted on material changes for the brand, they also will now have exclusive territories in which to operate, caps on their wholesale costs and the ability to decide who takes over their business when they retire. None of that had been guaranteed before. Also, competition between franchiser and franchisee is reduced under the new contract, while the company's revenue stream grows substantially. Previously, Culligan collected revenues only on equipment sales, but now will receive them on all aspects of the business. And in an extraordinary move for a franchise operation, the new agreement allows dealers to become part owners of the company.

While there are economic trade-offs on both sides, the dealers' attorney, Peter Singler, a Sebastopol, Calif., franchising specialist, says the "real benefits would be realized in the future, from a renewed and strengthened relationship and better alignment of economic interests."

Independent Streak
Long the premier name in water softening, Culligan International Co. is now a major player in residential bottled water as well. It also sells purification systems to commercial and industrial customers world-wide. The backbone of the company's U.S. business is a network of about 650 dealerships, many of which have been in the same family's hands for generations. Some dealers can even trace their franchise back to founder Emmett Culligan, who got a rural Minnesota blacksmith to assemble his first softener in 1936.

Typical of many franchisees, Culligan's dealers see themselves as independent businesspeople who concentrate on building their local customer base and assume that management will look after the brand. But the rules under which they operated changed as owners rotated through the company. Franchise agreements were frequently modified — sometimes when new products were introduced. And since older franchises were grandfathered in, the result was a hodgepodge of arrangements that benefited some dealers more than others and created confusion over their legal obligations.

Then in 1998, that system was rattled. A competitor, U.S. Filter Corp., bought the brand for $1.5 billion and began to overhaul it in a manner many dealers found financially threatening.

U.S. Filter's chief executive at the time, Andrew Seidel, says his firm concluded that Culligan had been starved by previous owners and needed a capital infusion and other major changes. "We said the parent has to make money so we can reinvest in" research and development and introduce new products, he says. "We tried to put some practical business sense back into the relationship between dealers and the company."

But the squabbling continued. Within four years, U.S. Filter was acquired by French conglomerate Vivendi SA, and Culligan became part of its portfolio of environmental enterprises. Then a series of ill-advised moves put Vivendi in financial straits, and, in 2004, Culligan was on the auction block again.

That's when Culligan's dealers decided that this time things would be different. "We said, 'We're tired of going through this. We're going to become active in the sale process,' " recalls Arthur "Buzz" Cooksey, now chairman of the Dealers' Advisory Committee, which represents dealers in negotiations with the company.

After toying with the idea of buying the business themselves, a group of dealers decided to lobby potential buyers. Among those they called on was Clayton, Dubilier & Rice, a private-equity firm in New York experienced in acquiring, overhauling and reselling businesses ranging from lawn care to cosmetics. Not long after, Clayton Dubilier submitted the lone and winning bid for Culligan.

Citing its private nature, Clayton Dubilier declined to comment for this article other than to say there's "a trust-based relationship" today between Culligan and its dealers. Representatives of Culligan International, based in Northbrook, Ill., declined to be interviewed.

Fresh Start
The dealers say Clayton, Dubilier & Rice told them it was prepared to consider a fresh franchise compact. The goal was to align interests, recalculate the business model and remove nettlesome issues that for years had strained relations between franchiser and franchisee. For dealers, it also represented an opportunity to incorporate their needs into a binding document that would give them long-term assurances about their futures.

Yet despite early optimism, the initial draft incorporated few of the dealers' suggestions, they say.

Missing, for example, were limits on the prices Culligan could charge them on equipment purchases. The dealers say they also had wanted compensation for water softeners and other treatment items that big-box retailers in their territory might buy directly from the company. But that wasn't there, either. Nor was flexibility in choosing their suppliers.

Culligan's management then exacerbated matters by holding town-hall meetings with dealers around the country, urging them to sign the new document and, some dealers say, threatening them with termination if they didn't.

Dismayed, the dealers called an emergency meeting in Dallas in May of last year, where they made a fateful decision: If they couldn't get their new franchiser to make significant concessions, they would leave the system, en masse, and start their own rival company. They worked up a marketing plan and began lining up potential suppliers.

Mr. Singler, the attorney, attributes their determination largely to "years of tensions that had built up with previous ownership and management teams."

John Packard, a Minnetonka, Minn., dealer who took part in the negotiations with Clayton Dubilier, recalls delivering the news to the firm when the two sides reconvened. "I told them, 'You have a decision to make. You can either join us and own the No. 1 water-treatment company in the world or go your own way and be No. 2 — behind us.' "

Dealers say they weren't worried about going it alone. They say they knew that their customers saw them as much as a hometown water-treatment expert as the Culligan Man. "I'm the local guy they've known for years," says Henry Strait, a dealer from Beaumont, Texas.

"When they realized we weren't bluffing, they snapped around pretty fast," says C.R. Hall, a dealer in Wichita, Kan. Mr. Hall says the nature of his business allowed him to consider forsaking the brand. "I'm not like a McDonald's if I took my sign down and became Hall's Hamburgers. Our business is very stable, and we have a high market share," he says.

Ironing Things Out
Within a few days, both sides sat down again and, as Mr. Singler put it, "got things ironed out."

What emerged was a franchise agreement giving dealers more security, by doubling the length of their franchise, and giving the franchiser more sources of revenue, beyond equipment sales. Moreover, the agreement clarifies or eliminates differences between previous contracts, on such issues as contributions for advertising and termination infractions.

Many franchise agreements are designed to give the franchiser firm control over the business. Often that assumes that despite their significant investments, dealers are treated largely like employees. But the Culligan pact reflects more of a true partnership, with shared decision making, mutually supportive financial goals and, perhaps most important, mutual respect.

Among the pact's significant points:

  • The company collects a royalty on every dollar of revenue dealers take in — from equipment sales and rentals to service work. The amount depends on the item. Previously, the company made money only on equipment sales.
  • The franchise agreement is for 20 years, twice the length of previous contracts. And dealers have a right to renew a franchise on then-current terms.
  • Dealers must be consulted on critical changes to the business and hold some veto power. Before, they had little or no say.
  • Culligan reduced prices on current equipment and capped future equipment prices charged to dealers. The company can't impose changes costing dealers more than 1% of their gross revenue.
  • Except in some promotional periods, the company won't advertise suggested retail prices without dealer approval. Doing so could undercut dealers' profits, since they would be compelled to sell a product at that price for fear of alienating customers.
  • Dealers are now paid for all warranty work and get a royalty on company sales to big-box retailers.
  • The company gave up what previous managements had said was the right to examine dealers' customer lists. In the past, some dealers had worried that Culligan could potentially move in on their best customers.
  • Dealers have exclusive territorial rights for residential business. In previous contracts, Culligan had contended that territories weren't exclusive.
  • Dealers can pass on their dealership to a qualified successor, and the company has no right of first refusal.
  • Dealers can buy as much as 10% of Culligan's stock. Shares of publicly traded franchisers like McDonald's Corp. are available on the open market, but it's rare for a privately held franchise like Culligan to let its franchisees become stockholders.

Allowing franchisees to buy shares in Culligan isn't part of the economic equation. Yet, so far, it has sweetened the deal for those that have done so. "On a $10-a-share investment, we've already received back about $2.60 [in dividends and a capital reimbursement], and the stock is still valued at over $11," says Mr. Strait, the Beaumont, Texas, dealer.

'In the Right Direction'
Franchising experts familiar with the Culligan contract seem generally impressed.

Marco Grunhagen, who teaches about franchising at Southern Illinois University in Edwardsville, Ill., says the clause giving franchisees the right to choose their successor "provides an incentive to invest all of their efforts" back into the business, thus enhancing its value for the company as well. "Traditionally," he says, "toward the end of a contract, franchisees may have little incentive to follow very strict standards, as they know they'll lose" the business.

Susan P. Kezios, president of the American Franchisee Association in Chicago, calls the accord "definitely a step in the right direction, on a number of levels." One is that the company has no right of first refusal on transferred dealerships, enabling franchisees to leave a legacy if they want. "A lot of franchising has moved away from that," she says. Extending the franchise's term to 20 years similarly encourages new franchisees looking for long-term investments, she adds.

To ensure that the contract is being followed, and to deal with day-to-day issues, senior management and the dealer leadership meet at least twice a year. And the dealers' association, called Culligan Dealers Association of North America, and the company hold a joint annual convention.

The arrangement isn't perfect. Mr. Singler, the dealers' attorney, alludes to "a few head-butting sessions over interpreting the new franchise."

Mr. Packard, who has 19 dealerships in Minnesota, calls it "a bumpy road." Of Culligan's new owner, he says, "They've made some mistakes, and they're correcting them. In the past, they would have kept on making mistakes. Now we're talking about how to grow the system together. We haven't done that in 20 years."

— Mr. Gibson is a special writer for Dow Jones Newswires in Des Moines, Iowa.

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