kabloom explodes on the scene - 24houranswers...gerald stevens was to start a national chain of...

©2008 Vega, G., Dumas, C., Hartstein, D. Kahn, B., Mana, J., & Sergenian, G.

KABLOOM EXPLODES ON THE SCENE

“We are going to become the Starbucks of flowers,” explained David Hartstein just before he launched his new business in 1998. As the market for consumption of flowers in the U.S. expanded, Hartstein wanted to take advantage of the opportunity to sell more flowers with a cash and carry business model. To do so, he created KaBloom, and within a year it had become “A Hot Start-Up” according to Inc. Magazine. Hartstein saw unlimited potential for his new business model, and his early success attracted venture capital investors who encouraged him to grow faster and faster. The pressure to grow became intense and, in 2002, he began to sell franchises. By 2005, KaBloom had over 100 franchised operations across the country, but problems were mounting. Hartstein had to do something to staunch the outflow of money. “But what?” he wondered.

The Floral Industry In 1998, as David Hartstein was preparing to launch KaBloom, the $15.5 billion retail floral industry was highly fragmented. While florists generally attempted to provide consumers with a selection of high quality fresh cut flowers, neither their prices nor their on-site assortment compared competitively with what he was prepared to offer. Some supermarkets sold flowers at a perceived low price, but their quality, freshness and selection were questionable because of the short shelf-life of the product.

The three main floral product categories consisted of: 1. Cut flowers and greens (arranged and pre-arranged bouquets, grower bunches and

single stem flowers) was the largest category, comprising 42 percent of the floriculture market, growing at a compound annual growth rate (CAGR) of 5.6%.

2. Potted flowers and potted foliage (flowering and non-flowering plants and trees that remained potted indoors and required careful maintenance) had experienced annual growth in the previous ten years of 8.9 percent per annum for potted flowering and 2.6 percent for potted foliage.

3. Bedding and garden products (kept outdoors, typically resided in pots, hanging baskets, or patio planters). This segment (17 percent of the total floriculture market) had been growing at a rate of 18.4 percent annually.

As the market expanded, U.S. consumption of fresh cut flowers grew from $17.40 to $26.80 per capita over the ten-year period from 1985-1995 (IAMCO). Total per capita consumption of fresh cut flowers, potted flowering and foliage plants reached $50.60 in 1996 from $34.50 in 1986. In 1998, the U.S. ranked twelfth in the world in per capita consumption of flowers, with Switzerland, Norway, Austria, Germany, and Sweden (the European countries that sold primarily via cash and carry) holding the top five positions. A window of opportunity to sell more flowers in the U.S. via cash and carry seemed open to Hartstein.

Retail Sales Channels There were two primary retail sales channels: (1) mass market representing 33 percent of sales and (2) specialty stores 57 percent of sales. Florists were the main retail seller, accounting for 34 percent of total floriculture sales. Supermarkets were the principal channel within the mass market, accounting for 14 percent. Each of these retail channels had a distinct strategy for generating revenue and filled a particular niche. Florists generally focused on providing value-


added services such as floral arrangement design and deliveries, while supermarkets focused on cash and carry and sold bouquets at lower price points. As a result, each retailer’s floral sales had a different breakdown for product categories. (See below for additional sales information).

Retail Sales Channels (Source: IAMCO 1996)

Mass Market

Specialty Market

Channel Sales

($ Billion)

Percent of Total

Channel Sales

($ Billion)

Percent of Total

Supermarket $2.2 14% Florists $5.3 34%

Discount $1.3 8% Garden Center $2.5 16%

DIY/Hardware $1.0 7% 800 number $0.3 2%

Other $0.6 4% Other $0.7 5%

Total Mass $5.1 33% Total Specialty $8.8 57%

Sales Channels and Items Sold

Category Fresh Cut Flowers

Potted Flowering

Potted Foliage Bedding and Garden

Florists 62% 20% 18% 3%

Other Specialty 8% 27% 27% 50%

Supermarkets 17% 18% 12% 6%

Other Mass 6% 24% 29% 30%

Other 7% 11% 14% 11%

Total 100% 100% 100% 100%


In 1996, 36,000 traditional florists operated in the U.S. with typical sales per store at $191,000 (IAMCO, 1996). Only 2 percent were affiliates of a chain. Traditional florists were order takers, not marketers. Local deliveries were critical to their business, and they relied heavily on phone orders (approximately 90 percent of sales were phone orders), with limited walk-in and cash and carry business.

In 1996, 48 percent of the 29,900 supermarkets in the U.S. had floral departments (IAMCO, 1996). These departments were located primarily in the produce section, which limited the life of the flowers because fruits and vegetables emitted ethylene, a gas that hastened the deterioration of flowers. The bulk of the floral industry was the order and delivery segment, which accounted for 70 percent of the dollars spent on fresh cut flowers; the average dollar transaction at a florist shop was between $25 and $40. Cash and carry, dominated by supermarkets where the average floral sale ranged between $5 and $10, accounted for 30 percent of the dollars spent but 60 percent of the total transactions. The remaining 40 percent of total transactions were for orders and delivery (IAMCO, 1996).

From 1989 to 1996, growth in the floral industry came primarily from three types of flowers: carnations, roses, and chrysanthemums. With the decline in domestic production of fresh cut flowers since the 1970s and the concurrent rise of imported flowers, the market changed dramatically (see Appendix B for information about cut flower distribution).

The History of KaBloom Office supplies and flowers had little in common, but David Hartstein (a former Staples executive and co-founder of Super Office, the first office superstore chain in Israel) and Thomas Stemberg, (former Chairman and CEO of Staples Inc.), felt the same passion about both of them. While traveling, they observed that Europeans purchased fresh flowers for special occasions and also as everyday items. Yet, despite their affluence, Americans ranked only 12th among the world's blossom buyers. Buying was largely limited to holidays and special occasions such as weddings, funerals or Valentine’s Day. In addition, Hartstein speculated, there was a difference in the way flowers were marketed in Europe compared to the U.S. European flower marts were generally larger and more inviting than their U.S. counterparts, and their prices were 35 percent lower. The big question Hartstein and Stemberg faced was whether it would be possible to reinvent the U.S. floral industry along the European model.

In July 1997, David Hartstein returned to Boston to promote the vision of buying flowers for personal enjoyment at any time. Hartstein and Stemberg decided to model their venture on Starbucks, whose success had come in great part by offering a basic commodity in a pleasurable environment. Starbucks had raised coffee’s profile, and Hartstein wanted to do the same with flowers, by offering a shopping experience that promoted convenience by making it easy for the consumer to get a wide choice of high quality flowers. He wanted shoppers to buy flowers as often as they bought the necessities of life, like groceries. Within 18 months, customers could buy KaBloom flowers three different ways: two KaBloom stores had opened, the website (www.KaBloom.com) was up and running, and 1-800-KaBloom was activated. The stores were particularly appealing with their bright purple awnings and


abundant flowers spilling out onto the sidewalk. They were located in high vehicle/foot traffic areas and resembled gardens, encouraging impulse purchases by passers-by. Hartstein said,

“We saw ourselves as a flower shop, not a florist. We were in the business of flowers. I became passionate about the business of flowers. I fell in love with it.”

The store managers were service-oriented associates who truly cared about flowers and plants, and they operated in company-owned stores that were creating a family of flower lovers. Store associates underwent an extensive training program in store service policies, and senior management maintained an active role in training and working with these individuals. Their remuneration was above average for equivalent positions in the Boston area, and various contests and incentive programs rewarded them for exceptional service and performance. Business Environment The U.S. floral industry was highly fragmented. An estimated 25,000 florists and 23,000 supermarkets shared the industry’s $14 billion total sales. Previous attempts to establish a floral retailing chain had failed. KaBloom’s approach was very different from the way the flower business had been conducted in the past, and even differed from the new model being put forth by Gerald Stevens, the mega-florist chain that opened around the same time as KaBloom. The owners, Gerald Geddis and Steven Berrard, had the idea of acting as consolidators for the highly fragmented florist market and providing central purchasing power and economies of scale for their “members.” These members were acquired through a variety of means, including partnerships, mergers, outright purchase, and other affiliations. They also bought successful stores in promising business areas. Geddis and Berrard had worked together at Blockbuster Video, the giant video rental chain that had achieved its considerable size by consolidating the video rental industry. Their goal for Gerald Stevens was to start a national chain of florist shops by acquiring 1,000 of the best local and regional florists in the country’s 100 largest markets to create a recognizable brand of flower shops. This process would be a “roll-up,” in which one company takes the lead and buys many smaller ones to create a large company that typically goes public. Berrard, Geddis and their colleagues were serious about the opportunity that the florist-chain roll-up offered. They planned to sink $10 million of their own money –along with a $20-million private placement underwritten by Allen & Co. – into the venture. Blockbuster had grown from a single store in 1985 to 3,700 stores by the time it was sold to Viacom in 1994 for $8.4 billion. Why couldn’t Gerald Stevens do the same? In the 1990’s, the floral industry seemed ripe for a breakthrough. And who better to take on the challenge of developing a national chain in the $15-billion industry than some of the key people responsible for Blockbuster’s stunning success? As Gerald Stevens cofounder Geddis told the Miami Herald at the time, the floral industry was “almost identical to the video industry in the mid 1980’s. It’s large, mature, fragmented, and there are no national brands.” By combining the best and the brightest of the floral community with their own vast knowledge of operating multiple retail stores, Gerald Stevens would create a powerful national brand in an industry that had always been void of very big players. Not only would they offer the florists a healthy cash buyout, but they would provide a shot at the public-market bonanza of the late 90’s. The principle of economics underpinning Geddes’ and Berrard’s strategy was the economies of scale Gerald Stevens would realize as the umbrella organization for a national network of floral shops. As a group, Gerald Stevens would realize appreciable savings through volume buying


and efficiencies in payroll, insurance and administrative functions. As a group, Gerald Stevens floral shops would benefit from increased advertising efforts, eclipsing by far the advertising efforts the shops could afford individually. They would benefit from stepped-up customer service and sales training, as well as the latest computer system and people on staff to service it. Further, the shops would benefit from any affiliations the corporate office forged with flower growers, adding to the incentives for floral shops to join Gerald Stevens. (www.fundinguniverse.com/company-histories/Gerald-Stevens-Inc-Company-History.html ).

On April 30, 1999 Gerald Stevens went public at $15 a share by doing a reverse merger with a Nasdaq-listed concern called Florafax International. (In a reverse merger, a new company merges with a company that is already public, and the merged entity is allowed to continue doing business as the listed company.) Florafax made sense as a reverse-merger partner. It was, at the time, a $13-million flowers-by-wire service that would direct business to Gerald Stevens's retailers. In December 1998, Florafax's stock was trading at $10, but by the beginning of February, after the merger was announced, the price topped $20.

During the next several months, the company continued to expand ferociously, using a strategy that relied on large industry leaders to go into the marketplace like missionaries and spread the gospel to their smaller colleagues. Gerald Stevens had purchased its own floral importer, AGA Flowers, which bought flowers directly from growers and sold them to retailers at highly competitive prices. Management also brought nationally recognized sales and customer-service trainers to Fort Lauderdale to educate the florists in a way the entrepreneurs never could have afforded on their own. And they held "best practice" roundtables, creating a community of peers that was rarely available to local small-business owners.

But flowers were not videos, as the Gerald Stevens executives were beginning to realize. The industry was aesthetic and emotional. Life-defining events, like marriage, birth, and death, were a florist's stock-in-trade. Over the next few months, a thousand little things just didn't go as planned. Company executives found that the initial acquisition stage of the business plan was far easier than actually integrating small, independent companies into a large public corporation. And there was trouble when Gerald Stevens began implementing policies that were designed to create exactly the kinds of economies of scale and uniformity that were the hallmarks of successful roll-ups. "We were fortunate to have some of the best florists in the industry," Geddis said. "It wasn't that we didn't appreciate their success stories, but we needed uniformity, consistency, and best practices." (www.inc.com/magazine/20030201/25127.html).

But there were more fundamental troubles plaguing the company. "We had flower shops operating on six different computer platforms, and the seventh method was a shoebox," said Eric Luoma. "There were no synergies." (www.inc.com/magazine/20030201/25127.html). Luoma, who was a Gerald Stevens regional vice-president, said that the company rejected the idea of off-the-shelf floral-industry software in favor of developing its own. So management spent approximately $5 million on a technology program, called LeafNet, that was delayed for more than a year. According to Royer, the long-awaited system never worked properly. In the meantime, florists sent their weekly sales numbers to Fort Lauderdale, where legions of accountants and bookkeepers tried to make sense of them. It often took management weeks to

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slog through the reports, and those delays made it difficult to do meaningful analysis. More than once, accounting errors weren't found until it was too late to fix them. "Around Christmas of 1999, we thought we were having a great year," says Royer. "Then we realized that the numbers were overstated in several markets by 15% to 20%." (www.inc.com/magazine/20030201/25127.html). It turned out that some florists who were transferring orders to other shops had reported total sales, and not just their commissions, as revenue. "There was a huge Bermuda Triangle between corporate management and the mom-and-pop retailers who didn't know what P&L and EBITDA are," said Karen Akin (www.inc.com/magazine/20030201/25127.html). That year the company posted a net loss of $12 million on revenue of nearly $111 million.

The lack of financial systems didn't deter Gerald Stevens from acquiring even more companies. Eventually, Gerald Stevens acquired more than 150 companies with 300 retail locations -- and wildly varying business models. And it seemed that every other kind of floral business -- including a cataloger, four call centers, an importer, and several Web sites -- found its way into the company stable as well. Revenue skyrocketed, but the company was bleeding cash.

In the spring of 2000, it seemed clear that the company was in a tailspin. Valentine's Day, Easter, and Mother's Day were among the biggest days of the year for florists, but sales still fell short of quarterly forecasts. In June acquisitions were suspended, and shortly thereafter Geddis stepped down from his post as CEO to become president of the company's retail division. John Hall, a partner in Steve Berrard's investment company, which at the time owned 17.8 percent of Gerald Stevens, replaced Geddis. Around the same time, CFO Al Detz and senior vice-president Adam Phillips left the company.

On April 23, 2001, the company filed for Chapter 11 protection. Gerald Stevens had drawn down a $32-million line of credit, had lost another $5 million in the first quarter of 2001, and had seen its stock price plunge to 9 cents.

On November 30, Gerald Stevens ceased operations, having spent $135 million to acquire approximately 300 flower shops in 33 markets. According to public documents, the company had raised slightly less than $52 million from the sale of its stores; it posted $73 million in liabilities.

Former CEO Geddis blamed the company's failure largely on the economy. "We were driven by a front-loaded acquisition program," he said. "When the money market slowed down, in 2000, our acquisitions slowed with it." Gerald Stevens never came close to its ambitious goal of acquiring 1,000 stores (www.inc.com/magazine/20030201/25127_Printer_Friendly.html).

KaBloom’s experience was dramatically different. The company kept its prices low--about half the industry norm--by buying directly from growers and distributors instead of purchasing from wholesalers, and it stocked more than five times as many varieties of fresh-cut flowers as the largest supermarkets and ten times as many as most florists. On-line, the company charged less than half as much as 1-800-Flowers, one of its major competitors.




KaBloom shops were twice as large as and better lit than many mom-and-pop shops. And the differences didn’t end there.

"The first thing a florist asks you is, 'How much do you want to spend?'" says Hartstein, adding: "We let customers make their own choices about what they want and how much they want to spend" (Reidy, 1998).

"A walk in our store is like a walk in a garden," claimed Hartstein. The KaBloom garden made flowers affordable to all. As Hartstein put it,

“In my day, asking a customer how much do you want to spend was a no-no. I wanted to take that out of the equation. The customer is in control because the prices are indicated by a tag in the flower container.”

The ambiance in most traditional flower shops was impersonal, with little contact between the florist and the customer; in contrast, KaBloom’s associates were trained to greet customers as soon as they entered the store. They made the store as much a part of the street scene as possible by opening the doors and letting flowers spill onto the sidewalk to enhance the impression of entering a garden.

“We created a common look for our stores, in design, lighting, layout and signage. We visually differentiated ourselves from existing florists. We created brand recognition, similar to what Starbucks had achieved,” explained Hartstein.

In 1999 INC Magazine named KaBloom a “Hot Start-Up”, an impressive accomplishment for someone who, as Hartstein said

“Had no background in flowers when I started. It’s a tough business to make money whether it’s a small shop or a big company.”

Harstein predicted that the company would gross $15 million in 2000 and expand to 150 stores by the end of 2003, at a cost of $250,000 per grand opening. To finance such an expansion, Hartstein did what he had done when he started KaBloom:

“Some of it was self-funded. Some came from family and friends. I also borrowed from boutique-style venture capitalists that I had met over the years. These are guys I know who have less than $100 million in funds and who make investments in businesses like KaBloom, financing anywhere from $10,000 to $500,000 dollars.”

While sales reached only $8 million in 2000, they did indeed grow to $15 million in 2001. However, nearly three years and one recession later, KaBloom failed to live up to Hartstein’s forecasted expansion, and KaBloom’s growth came to an end with just 34 locations. Unprofitable stores had to be closed, leaving KaBloom with 30 stores. Hartstein Experienced Three Problems

Issues with Distribution


The flower industry was complex and had one of the fastest product turnovers in the United States. Cooperation of all parties, from grower to distributor to retailer was necessary to bring the product to the end point - the consumer. Distribution had a critical impact on the quality of the flowers

The distribution process consisted of three distinct components: the broker/shipper dealing with local growers, the importer dealing with foreign grower and the wholesaler, and finally the mass market and specialty florist. The vast majority of flowers entered the United States through Miami from South America. From Miami, most flowers were trucked across the country to mass-market distribution centers and wholesalers. Each pair of hands that touched the flowers added both expense and delay for the consumer. By the time the local florist received the flowers, nearly a week had passed since they had been cut. Often, the flowers suffered for lack of refrigeration and/or water, arriving at their destination in a state of shock. The flowers needed time to rehydrate and recuperate before they could be sold, adding additional delay and reducing their shelf life. Flowers could not reasonably be expected to last for more than a few days for the customer. Shrinkage (loss as a result of the perishable nature of the product) could amount to as much as 15 percent of the total inventory.

In hindsight, Hartstein realized that in starting his business he had been somewhat naïve. His business plan could have shown him that the logistics of the flower distribution business were inefficient. For example, the wholesale price of flowers in Miami was $1.00 per stem, but consumers paid $6.00.

“I took a broken system—inside it was still rotten—I wrapped it in a nice package. I did the same thing as everyone else but I thought I was doing it differently. I didn’t understand that the system was broken. I didn’t use the market research that I had done that was in my business plan, which reveals the flaws in the flower distribution system. I should have identified then the need to eliminate some of the stages in the distribution channels,” said Hartstein.

New Faces and New Job Responsibilities

Along with his attempt to address the problems created by the lengthy distribution process, Hartstein faced resistance from his store personnel who did not wish to put in the long hours required to sustain the business. He wondered whether he should be hiring store managers as retailers or whether he should be looking for managers who could also work as floral arrangement designers. He decided to focus on the management end in the individual stores and centralize design and distribution in a Design Center in Woburn, Massachusetts. One unintended consequence of this decision was decreased employee morale. The task that they loved – the freedom to design flower arrangements – had been taken out of their hands. Worse, when customers complained about the design, employees still had to respond to the complaint even though they had had nothing to do with it. Employees became frustrated by this situation.

Even without high turnover and a demoralized staff, payroll could become astronomical. A store open 86 hours per week (see Appendix C for a Schedule of Hours Worked) required two employees in the store at all times to provide satisfactory service to customers. That meant 172 labor hours per week. Depending on the salaries paid staff, the cost of labor per year could amount to $130,000, which was much higher than the original estimate of $90,000 (see Appendix D for a Schedule of Estimated Fixed Costs). Original estimates of labor costs at 25 percent of sales meant that the store would have to generate gross sales of $520,000


($130,000/25%) to cover these labor costs. This was challenging to accomplish. (see Appendix E).

A Major Marketing Error - 2001

“Something is not right,” David Hartstein said to the six people around the conference table in the Woburn, MA headquarters. “How could a $1.5 million television commercial result in only a 4 percent increase in consumer awareness? This doesn’t make sense!”

Early in 2001, despite warnings from colleagues in the flower business about the expense and ineffectiveness of TV advertising for local sales, Hartstein believed he “could do it better,” and launched an aggressive campaign. It was a failure, resulting in a meager 2 percent growth in revenues instead of the anticipated 25 percent increase in comparative sales from 2000 to 2001. Hartstein and three Vice Presidents (Marketing, Merchandising, and Finance) sat facing the three ad agency representatives who were trying to explain how this could have happened. The presentation book before them was filled with data: pre-television commercial research, descriptions of the advertisements (with all the related data about channels, length, etc.), post-television commercial consumer research, and expenditures. What ensued was a very long discussion about expense versus results. The calculations were correct on paper, but in reality, the anticipated results failed to materialize. Everyone felt responsible; no one was happy, and no one had a solution.

A New Economy – A New Business Model The mood of the country turned somber after the events of September 11th, the impact of which was felt throughout the economy. A dozen of the company-owned stores were not performing well, and their failure was eating into the profits of the other 22 stores. Hartstein sought a way to connect the stores more closely to their respective neighborhoods and to reduce the high turnover of store personnel. One potential solution was franchising.

Because franchises operated within a proven system, their success rate was much higher than for other types of new businesses. The system included support via an established concept, a sound business plan, start-up materials (i.e., training materials, store design, sources for goods), and marketing advice.

A comparatively small investment on the part of the franchisor allowed KaBloom to expand the business and increase brand awareness rapidly with little risk. The franchisees, who paid the franchisor royalties on gross sales, absorbed the incremental financial risks. The franchisee’s major risk related to the royalties, which were payable regardless of profitability. The franchisor’s risk was the potential loss of control of an individual location, possibly impairing the brand of the franchise overall.

As long as the right people bought the franchises, the idea seemed to make sense – risk was limited and the income potential for the franchisor seemed boundless. (See Appendix F for a full description of franchising and risk/reward alternatives). However, KaBloom’s investors were opposed to franchising because it would not return as much immediate profit as company-owned stores. Although everyone’s goal was return on investment


(ROI), the franchising route would be a slower path than company ownership of retail outlets. However, Hartstein’s mentor advised him to move toward franchising as his own success with the strategy was well known. Hartstein was amenable and ultimately wrested control away from the investors. KaBloom took the plunge into becoming a franchised operation.

Investigating Franchising The earliest franchisees purchased existing KaBloom stores in the following way. First, they contacted KaBloom through a franchise agent or directly via the Internet. Then they submitted a series of forms including a net worth statement (i.e., a statement of what they owned and what they owed) and a statement of personal interest. If their personal financial situation was acceptable to the organization, the process continued. Sometimes, the potential franchisee was interviewed at this point; at other times, the individual was given a list of existing franchises and contact information so the potential franchisor could do due diligence (i.e., the thorough research required before engaging in a business arrangement).

After having been interviewed by KaBloom management (Franchise Business Consultants especially trained to do these interviews, and who reported to the COO), potential franchisees began negotiations regarding the terms of the Operating Agreement, which accompanied the UFOC (see below) directly with the COO.

The Federal Trade Commission required that all companies seeking to offer franchises provide a Uniform Franchise Offering Circular ten days before any money changed hands between a franchisor and a franchisee. This document, referred to as an UFOC, was a lengthy, expensive, and complex piece of writing that covered specific areas of the business. These included the franchising agreement, costs, obligations of both parties, restrictions, disclosures, and other important information. The UFOC could cost upward of a quarter of a million dollars to prepare; companies did not enter into such preparation lightly. KaBloom Franchising Corp, established for the purpose of selling KaBloom franchises, offered its first franchises on October 30, 2001.

The UFOC KaBloom’s UFOC specified certain arrangements that Hartstein and his team endorsed:

1 The retailing concept of flowers as an everyday necessity, European-style, rather than flowers only for special occasions (suggesting affordability and availability)

2 A collaborative approach to encourage franchisees to establish multiple locations within their territory at reduced costs, including the “Flower and Plant Wall” concept of providing flowers to alternate locations within the territory (such as gas stations or drug stores)

3 Fees for franchise purchase, start-up expenses, royalties, and related costs

4 Purchase of stock, equipment, and materials

5 Commitment on the part of KaBloom to provide advertising and business support

6 Training required prior to opening a franchise location.

By the time the UFOC had been issued, the discord between Hartstein and the investors had


become apparent. Tension between the investors’ goal of return on investment and Hartstein’s goal of ongoing royalties created conflict, and by February of 2002, KaBloom underwent a significant reorganization through capital restructuring. Hartstein assumed voting control by infusing more of his own cash into the company. As Hartstein explained, with a smug look,

“My strategy was to dilute the influence and power of other institutional investors who had not continued to raise funds for KaBloom. I also brought in new investors like my family. And there were some existing investors who sided with me and who also wanted to collect ongoing royalties, who contributed more money than the other investors. That’s how I got voting control and the ones who opposed me lost it.”

Euphoria to Dysphoria Once franchising had been decided as the operational strategy, KaBloom’s business took off in a period of euphoric growth. The first franchisee bought the Andover, Massachusetts store in March 2002. Hartstein’s goal was to get 60 stores on the books within one year. In fact, KaBloom grew from 34 stores to over 100 stores in just two years. Hartstein had anticipated that the franchisees would be owner-operators, loving flowers and working in the stores. He thought these franchisees would share his passion for a non-traditional approach to flower selling, and that they would devote their lives to the shops. He was thinking less of the franchisee’s ability to pay the fees and royalties. The ideal franchisee would be part of the community, would participate in community life, and would, most importantly, love flowers and share Hartstein’s vision. However, the concept of making profits one stem at a time did not appeal to all those who invested in franchises.

The Challenges

Hartstein’s sophisticated franchising advisors had made recommendations that worked in mature franchising operations but not as well in franchising start-ups. The franchise business consultant hired came from the restaurant industry and was not familiar with the flower industry. He ignored the differences between a KaBloom franchise and a fast food one. Potential franchisees only had to demonstrate that they had sufficient funds regardless of whether or not they had experience in retail, flowers or small business management. Selling the franchises became more important than carefully vetting each purchaser, and many of the franchisees were uninvolved in day-to-day operations. The result was stores with sparse inventory and virtually no shrinkage, instead of the anticipated 10 to 15 percent shrinkage. Shrinkage was important, because it would allow the shelves always to look abundant and lush despite the “holes” created by sales. The stores with insufficient shrinkage did not project the KaBloom profuse flower garden image.

Rapid growth

Franchising provided fast growth and required KaBloom to shift to a decentralized business model. By the end of 2005, KaBloom had almost doubled the number of franchised stores from 60 at the end of 2004 to over 100, while reducing the number of company owned stores from 30 to 10.

Hartstein instituted a new corporate structure to support the franchisees. It included a business manager for every 10 franchisees, as well as, experienced individuals at the vice president level to run the functional areas (i.e., information technology, marketing, logistics, and franchising).


Many of these vice presidents came from large companies where they had headed large departments with their direct reports doing the day-to-day work. The VPs built their own organizations at KaBloom similar in size and cost to the ones at their former employers, thus creating higher overhead than the fledgling organization could sustain.

Bleeding cash

The high expectations engendered by the franchise business consultants were requiring more cash outlays than was coming in. Franchises in distant locations such as Idaho and Texas implied extra shipping costs, with a resulting decline in quality of the flowers due to the extended delivery time. Hartstein had ideas about how to solve the distribution issue, but they took additional cash to develop. The added managers and supporting teams hired to administer the expansion created higher corporate payroll demands. When franchisees failed to pay their royalties, legal fees to pursue the debt exceeded the money that was eventually collected. Some franchisees were not paying for their orders on time. Because cash inflow was running lower than it should, the organization took on more debt and debt maintenance became a problem.

Distribution nightmare

The distribution of flowers needed special care. The product was highly perishable and had a very short life cycle. The distribution system consisted of three groups: the importer, the distributor, and the local wholesalers. The flower farms were located primarily in Colombia, while most of the distributors were located in Miami, Florida. Having distributors concentrated in one location was advantageous. It allowed pooling resources such as large refrigeration facilities, extensive logistics network, and USDA personnel to handle large volumes of daily flower shipments. The local wholesalers across the country were equipped with all the necessary resources to address the delicate nature of flowers on a micro-level.

KaBloom’s decision to implement a franchise system required several managerial changes. As the company grew so did the top management team. A vice president in charge of distribution with extensive experience in logistics operations was hired. A new distribution system was implemented as a result of the change in business model.

The distribution system adopted by KaBloom to handle the new franchise model was based on two parts: first was a central distribution center based in Woburn, Massachusetts. The center handled all the purchases for the New England area. The second was designed for the franchisees across the country. That sub-system received direct delivery from the growers in Bogota, Colombia. The flowers were flown to the farms’ warehouse in Miami, cleared by the USDA, and then distributed to wholesalers around the U.S. via independent truckers.

KaBloom assumed responsibility for ordering flowers for all its franchisees across the country, from Pennsylvania on the East coast to California on the West coast. However, delivery of shipments was often delayed or sometimes shipments were completely lost because small volume orders tended to receive lower priority in the delivery process. Many of KaBloom’s orders were small and, as a result of these delays, the quality of the flowers suffered. The price of flowers increased because the small volume shipments resulted in a loss in economies of scale. Company revenue took a dive, and the new operations model created new challenges for the company.


Disenfranchised The problems with the franchisees were never-ending. As Hartstein resolved one issue, another would crop up. “This is how you get yourself in trouble with decentralization,” Hartstein said.

“One franchisee had convinced himself that he could have one store and make huge profits from it. He hired a marketing manager for that one store and quickly got into financial trouble. KaBloom was buying flowers and selling them to the franchisees, laying out the money up front to the grower. Once the franchisee ran into trouble paying, KaBloom was left holding the bag.”

Because the corporate structure was decentralized, Hartstein was unaware of every such situation. His organization hired a law firm to file a lawsuit against that franchisee. The lawsuit stipulated that the franchisee pay $40,000 to clear the debt, which he did. Unfortunately, the law firm charged KaBloom $45,000, resulting in a net loss of $5,000.

“When you are decentralized, many decisions can backfire because of the lack of personal responsibility.”

Margins were so tight that errors and defaults could create major havoc. The plan to charge cost plus 10 percent for flowers offered little leeway for error, and when the franchisees did not pay on time, KaBloom had to cover the bills to the grower. The franchisees who paid on time didn’t understand why KaBloom was having trouble paying its bills and was demanding faster payment, and the franchisees who were delaying their payments continued to have a free ride. By 2005, between 10 and 12 percent of the franchisees were in default (see Appendix G for a timeline).

What was Hartstein to do? The time to make a major decision had returned.


Appendix A – Product Categories (Source: IAMCO - Independent Association of Mailbox Center Owners - 1996)

Product Categories % of Total Retail Floriculture Sales

1986-96 Compound Annual Growth Rate

1996 Dollar Value ($ Billions)

Cut Flowers and Greens 42% 5.6% $6.6

Potted Flowering 22% 8.9% $3.4

Potted Foliage 19% 2.6% $2.9

Bedding/Garden 17% 18.4% $2.6

Total Retail Floriculture 100% 7.9% $15.5


Appendix B – Distribution of Cut Flowers Cut flower distribution was complex due to four factors:

1. Flowers were both highly perishable, and different flowers survived for different time periods. While some flowers could be delivered to retail stores within 3 days, most flowers were not delivered so promptly.

2. Delivery logistics were extremely complex. Most flower products had to be refrigerated at all times whether the product was flown into the U.S. or trucked across the U.S.

3. Individual store volumes were low and, as a result, retailers either had to purchase at higher costs or offer a narrower product assortment.

4. Product variety was extensive and managing inventory was complicated. There was no brand awareness in fresh cut flowers and the assortments per variety could be quite high. Additionally, distributors were required to carry a large variety to satisfy complex demand.

Because of inefficient and complex distribution channels, distributors, wholesalers and retailers enjoyed high profit margins.

Cut Flower Distribution Channels

Local Grower

Foreign Grower

Wholesaler

Consumer

Mass Market

Local Floral Market

Importer Broker/Shipper

Importer Bouquet Division

Specialty Florist


Appendix C – Schedule of Hours Worked at Each Store

Mon Tues Wed Thurs Fri Sat Sun Total

Store Hours 8 AM-8

PM 8 AM-8

PM 8 AM-8

PM 8 AM-8

PM 8 AM-8

PM 8 AM-8

PM 10 AM-5

PM

Work Hours 7:30-8:30 7:30-8:30 7:30-8:30 7:30-8:30 7:30-8:30 7:30-8:30 9:30-5:30

Hours per employee 13 13 13 13 13 13 8 86

Appendix D – Estimated Fixed Costs per Store

Payroll Expense $ 90,000 Benefits and Taxes 8,300 Outside Labor - Rent 40,000 Utilities 7,000 Telephone 1,600 Automobile 3,200 Office Expense 4,000 Repairs and Maintenance 3,500 Other Operating Expenses 2,200 Miscellaneous 1,500 Floral Wire Costs 2,500 Professional Fees 1,500 Insurance 3,900 Bank Charges 5,200 Communications Fee 1,500 Other Computer Costs 1,200 Other Administrative Expenses 2,000

Total Fixed Costs $ 179,100


Appendix E – Contribution Margin

Sales Revenue 100.0% Cost of Goods Sold

(44.0%)

Gross Margin 56.0% Variable Costs

Non-Merchandise Revenue 5.0%

Supplies (1.5%) Marketing (3.0%) Credit Card Fees (1.5%) Total Variable Expenses (1.0%) Contribution Margin 55.0%


Appendix F – Franchising

The Uniform Franchise Offering Circular (UFOC) is a legal document used in the franchising process in the US and is governed by a rule of the Federal Trade Committee. This is also referred to as the Franchise Disclosure Document (FDD). Franchisors are required to give a UFOC to franchisees at least 10 days before any contract is signed and money changes hands. A UFOC consists of three parts:

1 Twenty-three items (see item definitions http://franchises.about.com/od/franchisinglegalissues/a/UFOC_blueprint.htm) describing various aspects of the franchise offering

2 Up to three years of the franchisor's audited financial statements 3 The agreement that the franchisee must sign if he/she intends to buy the franchise.

The UFOC includes the initial cost of the franchise, royalties on gross sales, products that can be sold and approved sources for products, and other requirements for individual stores, including store layout and procedures to be followed in operating stores (often called ‘the system’). A franchise covers a specific geographic area for a specific duration. The franchiser can cancel the agreement, and the relevant cancellation procedures are described in the UFOC. The following provides some “basic rules” of business from the KaBloom UFOC. They are similar to restrictions found in most franchising agreements.

1 The Products include: select varieties of flowers, plants and related merchandise that Franchisor designates for sale in all KaBloom Stores (“Core Products”); other flowers and plants that are popular, or customarily grown or sold, in the local or regional area of one or more KaBloom Stores and that are approved for sale by Franchisor (“Local Products”); other complementary and compatible merchandise and gift items designated and/or approved by Franchisor for sale in KaBloom Stores (“Accessory Products”); and certain merchandise and products bearing the Proprietary Marks or affiliated with the System and/or Franchisor, as Franchisor may specify from time to time (“Branded Products”).

2 The distinguishing characteristics of the System include, without limitation, distinctive interior and exterior decor, color scheme, design, and furnishings; product purchasing and sourcing procedures; uniform standards, specifications, procedures for managing inventory and quality control; training and assistance; and advertising and promotional programs; all of which may be changed, improved, and further developed by Franchisor from time to time.

3 The Franchisee shall purchase all equipment, supplies, services, and products (including the Products) required for the operation of the Franchised Business from manufacturers, distributors, and suppliers designated by Franchisor. Franchisor reserves the right to designate, at any time and for any reason, a single supplier for any equipment, supplies, services, or products (including any Products) and to require Franchisee to purchase exclusively from such designated supplier, which exclusive designated supplier may be Franchisor or an affiliate of Franchisor.


4 At the request of Franchisor, which may be made once during the term of this Agreement, Franchisee shall refurbish the Store at its own expense to conform to the trade dress, color schemes, and presentation of the Proprietary Marks in a manner consistent with the image then in effect for new KaBloom Stores under the System.

Summarized material:

The Franchisee was licensed to operate a store(s) in a specific “defined territory” (stated in the specific agreement between Franchisor & Franchisee) following the above rules. The initial franchise was for 10 years with options to renew 6 additional terms of 5 years each. There were some additional rules for continuing renewal. Franchisor provided sample floor plans, training to franchisee, and operations manuals. The Franchisee could not “own” competitive floral businesses during the tenure of the franchise agreement and for 2 years after.

Comparison of KaBloom’s Risk/Reward Alternatives

Franchising Own and Operate KaBloom Capital Investment Required

KaBloom Corporate Control

Speed of Expansion

Profit Potential

Risk Potential

Return on Investment


Appendix G – Timeline

May 1998 Business plan complete

July 1998 First round of equity financing raised

December 1998 First company store in Newton, Massachusetts

May 1999 Fourth company store in Cambridge, Massachusetts

December 1999 Second round of equity financing raised

December 1999 10 stores open

December 2000 23 stores open

March 2001 First TV campaign

Summer 2001 Franchising initiatives picking up steam

October 2001 34 stores open

November 2001 Top management clashes with investors about franchising

February 2002 Company reorganization, Hartstein assumed voting control

March 2002 First franchisee buys the store in Andover, Massachusetts

December 2004 Total store count 90

Mid- 2005 More than 100 stores open


References Fenn, D. (Feb 2003). The Sweet Smell of Excess, Inc. Magazine. IAMCO (Independent Association of Mailbox Center Owners) 1996.

Maxwell, J.H. (2002) Daisy Chain: Will Franchising Fertilize Growth For This Floral Superstore? Kellogg School of Management Magazine.

Pope, J. (Feb 16, 2001). Florist suffers delivery overload, The Boston Globe. Reidy, C. (Dec 25, 1998). An idea blossoms: KaBloom hopes to do with flowers what staples did with office supplies. The Boston Globe, D1. Tahmincioglu, E. (2004). Small Business: How to Grow Without A Lot of Capital. The New

York Times, January 8th.

Thomas, P. (2003). Small Business – Case Study: If A Business Template Isn’t Working – Change. Wall Street Journal, p. B3.

US Floriculture Industry: Data Sheet, December 1996 http://www.fundinguniverse.com/company-histories/Gerald-Stevens-Inc-Company-History.html

(retrieved May 11, 2008). (www.inc.com/magazine/20030201/25127.html The Sweet Smell of Excess. (retrieved May 26th,

2009.)

www.inc.com/magazine/199990701/821.html Hot Start-Ups. Ten Ideas for Businesses You’ll Wish You’d Thought of First (retrieved June 2008).

www.fundinguniverse.com/company-histories/Gerald-Stevens-Inc-Company-History.html (retrieved May 13, 2009).


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