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Is General Nutrition Headed For Civil War?


The Corporation

IS GENERAL NUTRITION HEADED FOR CIVIL WAR?

In a timeworn building a block from Pittsburgh's red-light district, a receptionist answers a stream of calls. From Florida to California, people phone to ask about franchises for General Nutrition Cos., the country's largest vitamin retailer. With GNC opening a new store almost every day, and a health-obsessed public anxious to whip cancer and midlife bulge, GNC is one of the hottest tickets around.

But at a GNC store in Monmouth County, N.J., prospects aren't so dazzling. Gina Cotto, who invested $150,000 to open a franchise 18 months ago, is running out of popular GNC products. With the company shipment running late, she offers customers other brands, on which she earns less. If they're sticklers, she knows they can find a well-stocked company-owned GNC store 10 minutes away, and she wonders if they'll ever return.

EMPTY SHELVES. Cotto isn't alone. In the five years since Boston investor Thomas H. Lee engineered a $361 million leveraged buyout and return to the public market for GNC, it has been widely promoted as one of the country's best--and fastest-growing--franchise operations. But growing pains are straining ties with franchisees, who number 430 and counting. While rapid expansion has been highly profitable for GNC, some franchisees complain that it is coming at their expense. They claim poor distribution has left stores unstocked, even as they face increased competition from new franchises and price-slashing company-owned stores.

Now, lawyers and a franchisee trade group are hurrying to unite the disgruntled retailers into an association aimed at winning a bigger chunk of GNC'S profits. "GNC is acting in a predatory manner with its franchisees," says American Franchisee Assn. President Susan P. Kezios.

BIG RISE. That's a charge company officials adamantly deny. GNC Chief Executive Officer William E. Watts admits that the contract between the company and its franchisees "is slanted toward us," as at most franchise operations. But he argues that explosive growth will benefit both, since the company will dominate the market. "When we own this industry, these franchises are going to be in an unbelievable position," he says.

Watts's vision finds plenty of believers on Wall Street. GNC's shares have more than tripled, to 27, since it went public nearly two years ago. Revenue, on target to hit $682 million for 1994, is up 50%, from $453 million in 1992, while analyst Marcia L. Aaron of Alex. Brown & Sons Inc. estimates earnings will top $45 million, a stunning tenfold rise. Investor Lee, who holds 45% of the stock, says judging GNC by disgruntled franchisees is akin to "looking at an elephant's toenail and saying it's the elephant."

The complaints about GNC aren't unusual in franchising. Still, observers say GNC's problems may run deeper than most. William B. Cherkasky, president of the International Franchise Assn., an industry trade group, says GNC's distribution difficulties are "a problem that it has to overcome, and overcome quickly." Adds a top franchise lawyer who works for several of the industry's biggest players: "It sounds like the company is shooting itself in the foot."

Following its 1989 LBO, GNC turned to franchising to spread its stores rapidly around the country while servicing its $360 million debt. In 1992, Watts hired Russell Cooper, who had tripled franchises at Arby's Inc. restaurants in the 1980s. Since then, GNC has opened most of its 700 franchises in the U.S. on top of roughly 1,300 company-owned stores. Stores are also opening in Mexico, Brazil, and Europe, while GNC gained 209 stores by buying its biggest rival, Nature Food Centres, in a $55 million deal last August.

But the buildup is overtaxing distribution from GNC's huge manufacturing plant in Greenville, S.C. With supplies tight, franchisees complain that GNC ships popular products to company-owned stores more often, while their shelves remain bare. "All my outside suppliers can ship to me in three days, max," says Cotto. "But I wait five weeks for GNC."

A BATTLE. Cooper admits distribution is suffering, but denies favoritism. He says many small franchisees don't stock adequate inventories, since it cuts cash flow. With a fourth distribution center opening next summer, he says the company is moving to resolve the problem. "The franchisees get mad about it," says Cooper. "But it drives me crazy."

Yet saturation remains an issue--particularly when company-owned stores launch price wars. While GNC battled Nature Food, company stores discounted many lines by 25%, and GNC urged franchises to follow--but offered them no discount on products. Franchises also had to offer customers 20% off on Gold-Card Tuesdays, a GNC promotion, and pay 7% royalties.

Such practices are common in franchising. But GNC's franchisees complain that because it manufactures its products--unlike most franchisors--it could have eased prices. The upshot: Rather than healthy 50% markups that GNC says retailers typically receive, some stores sold goods at a loss. "A lot of franchisees really got hurt," says Jack Sullivan, who runs four stores in the New York area.

The price war eventually paid off, driving Nature Food's earnings and stock price down to "where we could afford to buy them," says Cooper. That eliminated GNC's biggest rival, but left many franchises facing even more GNC outlets. One franchisee who runs a GNC store in Boston now battles three company-held Nature Food Centres within two blocks of the shop. Though pricing has improved, "I'm in competition with my franchisor," says the franchisee.

GNC executives say that for franchisees who market aggressively, rewards outweigh the risks. "If you're a mediocre operation, business could suffer, but we don't allow cannibalization," says Cooper. Indeed, there's room for optimism. Last month, President Clinton signed a bill limiting regulatory scope on vitamins. For GNC, says PaineWebber Inc. retailing analyst Gary M. Giblen, "It's a case of all stars coming into alignment."

Certainly, some franchisees are doing well. In 1989, brothers Jack and Richard Sullivan set up one of the first GNC franchises next to a Bally's Health Club in New Jersey. Traffic from Bally's fed growth and the brothers now have four franchises. While recognizing GNC's current troubles, Jack Sullivan says most complaints come from lazy operators.

For Barbara Savin, GNC's star has already dimmed. A longtime GNC employee, Savin started a franchise three years ago. Now, in a suit filed in September, she charges that GNC enticed her with overly rosy earnings projections and "lowball" estimates for startup costs. Savin's suit claims she lost an average of $60,000 a year after opening her Edison (N.J.) store in 1991, in part because GNC ordered her to cut prices to compete with Nature Food. When low revenues led to late payments, she says GNC held back products. Eventually, GNC took over her store, and in August declared her in default. "I was being totally strangled," says Savin.

A SPARK? CEO Watts says the suit is without merit. Company officials maintain that the numbers they gave Savin were average sales and startup costs from comparable GNC franchises--not projections. And they say the store would have been profitable if she hadn't taken money out of it to pay hospital bills for her sick daughter, a charge Savin denies. "We carried her for two years," says Cooper.

While Savin's experience was far worse than the typical GNC franchisee's, her fight could well spark the creation of an association that taps into the frustrations others feel. Kezios of the franchise association mailed out the first wave of organizing letters in late October. Such a union won't halt GNC's rapid growth. But it might tilt the balance just a bit more toward the franchisees, the foot soldiers in GNC's global vitamin campaign. GNC's Growing Pains

Adding 350 stores a year fuels healthy profit growth, but franchisees are grumbling

WHAT FRANCHISEES CHARGE

GNC favors company-held stores by supplying products to them more often, while franchisees wait

The company furnished overly rosy projections of startup costs and profits

An overtaxed distribution system leaves store shelves empty

Buyout of rival Nature Food Centres means too many stores in some areas

WHAT GNC SAYS

Company denies favoritism. It says franchisees need to invest in more inventory--but don't because it cuts cash flow

GNC figures are average performance at comparable stores, not projections

The company is adding a new distribution center to strengthen delivery

Despite short-term pain, well-run stores that market aggressively are gaining share

Stephen Baker and Keith L. Alexander in Pittsburgh


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