Johnston Processors Limited
Charlie Johnston, President of Johnston Processors Limited, operators of three One Hour Drycleaning franchises, sat in his office in downtown St. John's and considered the information in front of him. It was March 28, 1991, and Charlie's accountant, Harry Wood, had just presented him with a draft copy of his financial statements for the year ended January 31, 1991. "This indicates that we've experienced another decrease in sales and profits," Charlie commented. "Obviously, our bankers will not like this situation at all. This would have a severe negative effect on my other companies. As you know, my wife, Marie, and my daughter, Christina, operate this company. We'll have to analyze this company's situation further to see where our problems are and what can be done to solve them." Harry, of Wood and Smythe, Chartered Accountants, nodded in agreement. "Unfortunately, we won't be able to do the analysis for you. As a small, independent firm, our personnel resources are stretched to the limit at this time of year. Why not ask someone from the University's Small Business Centre to conduct this study?"
Background Information
Charlie Johnston was the operator of several small companies in the Avalon Peninsula region of the Province of Newfoundland and Labrador. Over the years Charlie had been moderately successful, and had, in fact, accumulated considerable personal wealth. Charlie's wife, Marie, was a nominal shareholder in most of Charlie's companies, but
This case was adapted from a case prepared by Professor Wayne King for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Material in this case has been disguised.
Copyright © 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.
with the exception of the drycleaning franchises, did not play an active role in management. 'When the kids were younger, I felt more comfortable working at home, raising our family," Marie recalled. "However, when Christina, our youngest daughter, finished high school, I found I had sufficient time to make a contribution to the businesses. Originally, I wanted to become involved in some of the existing companies, but they already had management people in place and were operating smoothly. As well, Christina was having difficulty in finding employment. Charlie and I decided that we would look for a new opportunity for Christina and me to start UP."
The Johnstons determined that a franchise arrangement would be the most suitable for Marie and Christina. They felt that franchises had several advantages, including recognition by customers, national advertising, assistance with store design and location, and advice in other areas if necessary. The disadvantages were the high initial franchise fee and the relatively expensive royalty and advertising payments required by the franchise agreement. In 1982 the family spent several months reviewing the 'Business Opportunities' sections of several business magazines and newspapers. They decided to proceed with the acquisition of a 'One Hour Drycleaning' franchise, a selfcontained drycleaning store designed to operate from a shopping mall. "We felt that the concept was logical," Marie commented. "A customer could drop off cleaning, shop for a while, and then pick up the cleaned clothes on the way out." In addition, Charlie thought it was favourable that the franchisor indicated that a gross profit percentage (gross margin/sales) of 65% should be earned on sales. Later in 1982, the Johnstons opened their first store in St. John's largest shopping center. The stores were relatively expensive to establish; the initial franchise fee was $40,000 per location, equipment cost approximately $165,000 and leasehold improvements of $75,000 were required.
Over the next four years the company prospered. Two years after the first store was opened, a second store was set up at the other large mall in St. John's. A third store was started about a year after that, also in St. John's. Shortly after the opening of this third store, the company's performance began to deteriorate. Several reasons for this were advanced by Marie Johnston. "First, we can't seem to hire people who care about working any more. Consequently, our turnover is high. just as we get our employees trained to operate the machines, they leave to work at one of our competitors. Also, we have been having trouble with the machines. The manufacturer has no local repair or parts service, so even minor problems can create delays in satisfying customers' orders. We also have more competition. Presently, there are more cleaners in town than ever before. In fact, the operator of the mall where our first and biggest store is located has just allowed one of our competitors, which had a dropoff location there, to install a service somewhat similar to ours. We complained, but there doesn't seem to be much we can do about it."
About a year ago, the Johnstons had been approached by two separate groups who expressed an interest in acquiring one or more of the stores. The first inquiry was from a group of local investors who bought and sold small companies as investments. The second was from an individual who had spent more than 20 years managing a cleaning store for an owner who did not spend much time with the business. This individual had decided to investigate the possibility of acquiring his own store. At the time of the inquiries the Johnstons were not interested in selling, however, Charlie, in particular, was beginning to wonder if this option might still be open. "Interest rates have been falling for some time now. This will help make it easier for prospective buyers to meet their financial commitments. As well, the overall market for drycleaning services is increasing annually through inflation."
Organization
Although Charlie Johnston was listed on the company's records as President, he actually had little contact with it, except to review the monthly sales reports, and to negotiate lines of credit with the company's banker. Marie, as VicePresident, was in charge of the daytoday operations, assisted by Christina, who worked full time at the stores. The accounting was done by a bookkeeper, Valarie Anthony, who worked at Charlie's office and maintained accounting records for several of his companies.
Marie Johnston originally saw her role in the organization as being in the policy area. However, this had changed recently. "We've had some very difficult decisions to make here in the past two to three years," she said. "Unfortunately, because of the decline in sales, we've had to insist that employees pay for their own uniforms. We've also been unable to adjust wages, except to keep pace with minimum wage movements. We laid off our store managers about a year ago, again for costcutting reasons. Since then, Christina and I have spent most of our time going from store to store to ensure things are running smoothly."
The Problem
After the meeting with his accountant, Charlie called a meeting with Marie and Christina and discussed the options available to them. Marie and Christina were positive about the stores and their ability to effect a turnaround. "We are the ones who know the business first hand," said Marie. "I feel that if we spent some money upgrading the stores' appearance, which we have had to allow to deteriorate somewhat, and in overhauling the equipment, we will attract our customers back. We should also increase our advertising." "I'm not so sure," replied Charlie. "We've already invested a substantial amount of our own funds in these stores. Maybe we'd be throwing good money after bad. Besides, our national advertising expenses are already pretty high. I really have no idea whether there is enough business out there for us to be successful. Perhaps I should check to see if the potential buyers from last year are still interested."
The Alternatives
After further discussion, the Johnstons summarized their options as follows:
· Invest an additional $40,000 of personal funds in the stores to upgrade the appearance and equipment;
· Increase bank borrowing by $40,000 for the same reason;
· Sell one or more of the stores;
· Close one or more of the stores.
At the Johnston's request, Valarie and Harry prepared a statement of cash flow for each store for the most recent financial year. In addition, cash flow statements for the past three years were collected. Also, Marie prepared what she felt were reasonable operating forecasts to support her contention that an additional investment was justifiable. (Exhibits 1 to 3). Charlie was anxious to have the data analyzed and looked forward to the report from the Small Business Centre.
Questions
1. Evaluate whether the Johnstons are adequately "managing" the company by answering the following questions:
a. Is there evidence of regular planning and budgeting on the part of management?
b. Calculate the company's gross profit percentage of each store for 1991 and of the company as a whole for 1988 1991. Do you feel they are reasonable? If you were the manager, would you be satisfied with these figures? Do you feel the company is controlling its gross profit percentage?
c. Is Marie's idea of spending more on advertising a good one? Should she try something else before increasing expenditures on advertising?
d. From the information provided, how would you assess relations between management and employees?
2. Using the 1991 actual figures as a base, analyze Marie's operating forecasts. What kinds of increases or decreases can you see? Are they reasonable?
3. Based on the information given about the company and your assessment of its owners, rank the options open to the company. Provide reasons for your rankings.
Exhibit 1
Johnston Processors Limited
Statement of Net Cash Flow
For the Year Ended January 31, 1991
Store I / Store 2 / Store 3 / Total$ / $ / $ / $
Sales / 396,405 / 296,894 / 207,989 / 901,288
Cost of Sales / 178,977 / 125,009 / 81,977 / 385,963
Gross Margin / 217,428 / 171,885 / 126,012 / 515,325
Bank Loan Proceeds / 22,000 / 16,000 / 12,000 / 50,000
Expenses
Wages and benefits / 79,768 / 59,744 / 41,854 / 181,366
Interest charges / 14,627 / 10,945 / 7,670 / 33,242
Travel / 4,679 / 3,500 / 2,454 / 10,633
Royalties / 38,993 / 29,177 / 20,451 / 88,621
Rent / 55,316 / 38,488 / 26,841 / 120,645
Advertising / 9,295 / 6,956 / 4,875 / 21,126
Loan repayments / 31,336 / 31,336 / 31,335 / 94,007
Other operating costs / 20,984 / 15,701 / 11,005 / 47,690
254,998 / 195,847 / 146,485 / 597,330
Net cash flow
for the year
(15,570) / (7,962) / (8,473) / (32,005)
Exhibit 2
Johnston Processors Limited
Forecast Cash Flow Statements
For the Years Ended January 31
1992 / 1993$ / $
Sales / 982,200 / 1,064,860
Cost of Sales / 376,476 / 408,160
Gross Margin / 605,724 / 656,700
Bank Loan Proceeds / 40,000
Expenses
Wages and benefits / 155,720 / 168,810
Interest charges / 14,600 / 14,600
Royalties / 78,576 / 85,188
Rent / 120,645 / 120,645
Advertising / 34,400 / 37,300
Loan repayments / 19,400 / 17,700
Other operating costs / 47,700 / 47,700
Repairs & maintenance / 40,000 / 5,000
511,041 / 496,943
Net Cash Flow / 134,683 / 159,757
Exhibit 3
Johnston Processors Limited
Statement of Cash Flows
For the Years Ended January 31
1991 / 1990 / 1989 / 1988$ / $ / $ / $
Sales / 901,288 / 1,034,713 / 1,122,879 / 1,027,559
Cost of Sales / 385,963 / 401,899 / 437,255 / 397,047
Gross Margins / 515,325 / 632,814 / 685,624 / 630,512
Bank Loan Proceeds / 50,000
Expenses
Wages and benefits / 181,366 / 181,459 / 218,033 / 182,223
Interest charges / 33,242 / 24,777 / 12,448 / 13,750
Travel / 10,633 / 15,095 / 20,410 / 17,601
Royalties / 88,621 / 99,288 / 106,297 / 97,483
Rent / 120,645 / 117,624 / 114,487 / 95,176
Advertising / 21,126 / 47,568 / 30,430 / 38,078
Loan repayments / 94,007 / 106,969 / 103,739 / 75,441
Other operating costs / 47,690 / 53,976 / 46,524 / 46,944
597,330 / 646,756 / 652,368 / 566,696
Net cash flow for the year / ( 32,005) / (13,942) / (33,256) / (63,816)