Growth Strategies: Buy or Build

During one of the most popular Main & Wall sessions, Marty Allen, CEO of Party America, and Dale Merrill, president and COO of Kiddie Kandids, discussed the differences in external vs. internal growth tactics. Both retailers have led their respective companies through aggressive and successful growth cycles, but Party America relied predominantly on acquisitions, while Kiddie Kandids grew organically.

Buying dominance: Within 60 days of assuming the CEO role, Allen realized the party was over and he took the struggling 24-store chain into Chapter 11.That was his first strategic move at Party America. Next he partnered with Gordon Bros., Boston, to help turn the company around.

Matthew Kahn, principal, managing director of GB Merchant Partners (a division of Gordon Bros.), explained why his company was eager to join the party, despite the dubious Chapter 11 status.

“The reason Party America was in bankruptcy was totally unrelated to its existing management team, which we had confidence in,” he said. “Also, the company had very good real estate in three core markets [San Francisco, Los Angeles and Denver]. Our strategy was for Party America to become the consolidator, protecting its real estate investment and acquiring other retail chains at liquidation value.”

Of the 288 stores now in the Party America chain, all but the original 24 stores and 18 newly constructed stores were added through acquisitions. In August 2003, 86 Paper Warehouse stores were absorbed with relative ease.

The Paper Warehouse locations were a good cultural and geographic fit for Party America. However, in October of the following year, the retailer bit off almost more than it could swallow with the acquisition of 160 stores owned by Party Concepts.

“Halloween is our Christmas season, so the Oct. 8th closing was terrible timing. It would have been much better if we had waited another year before doing a second portfolio acquisition,” said Allen.

However, the strategic beauty of the two acquisitions was that there was zero overlap in market locations, allowing Party America to become the second-largest party retailer in the country in two fell swoops, with no cannibalization of its existing stores.

Advantages of an acquisitions strategy, per Allen, are rapid growth, elimination of competitors and instant buying leverage. On the downside, acquiring large portfolios stresses the parent retailer’s existing infrastructure, involves massive changes throughout the organization, and requires a lot of money—all of which has to happen simultaneously.

Culture shock: “The biggest challenge we faced was [transitioning] the company culture,” explained Allen. “We had to hire 50 people in 90 days. That’s tough for any company but especially for a small, un-sexy retailer.”

Party America also had to bring all of the newly acquired stores up to speed with its corporate systems and technologies. “We suddenly had 160 new stores that couldn’t spell customer service and many didn’t even know what DSL was. We never considered that the whole U.S. was not wired for DSL, and, if we didn’t have DSL, we didn’t have systems,” Allen continued.

Fortunately, a friend based in San Francisco was a professional “culture doctor” and was willing to consult with Allen to help give the newly expanded retailer cause for celebration.

“Once the culture was fixed, we doubled our EBITDA [earnings before interest, taxes, depreciation and amortization] numbers from 2005 to 2006,” concluded Allen. “Acquisitions are a wonderful way to speed growth, but you almost need to have two management teams for a smooth transition—one to run the company and one to do the merger.”

In September 2006, Party America was acquired by Amscan Holdings of Elmsford, N.Y., a leading manufacturer of party supplies and owner of Party City, the largest party-goods retailer in the United States, with more than 500 stores and Party America’s primary competitor.

‘Kandid’ snapshot: From its birth in 1974 as a photo kiosk in Orem, Utah, to its modest expansion into 14 mall-based studios in 1988, to its coming of age as a digital-based photo studio in 1999, Kiddie Kandids’ growth seemed to follow the natural evolution of systematic, gradual organic expansion. To finance its growth, Kiddie Kandids partnered with CapitalSource of Boston.

The decision to become an “all digital” photo retailer was a stroke of genius, and just enough ahead of the curve to catch mainstream America’s virtual overnight adoption of the new technology. By the year 2000, Kiddie Kandids was converting all of its existing studios to digital, as well as maturing its market position with the perfect partner: Babies “R” Us.

The marriage of two niche retailers catering to the unique age bracket of infants to 4-year-olds was a match made, if not in heaven, certainly on Wall Street. In 2003, Kiddie Kandids opened its 100th studio, and by the close of 2006, there were 153 studios in 28 states, of which 105 were licensed departments operating as stores-within-stores inside Babies “R” Us locations.

“We had a 33% growth rate in 2006, opening nine mall stores and 29 Babies ‘R’ Us locations,” reported Merrill. “We also had a 26% compound growth in sales volume, and ended 2006 at $64.4 million.”

With its mature, proven concept, the retailer plans to maintain an aggressive expansion plan, opening 43 stores each year over the next five years and tripling sales volume over the same period.

Opportunities for organic growth remain strong, as Merrill noted: “Babies ‘R’ Us is the dominant player in that [market] niche. There are [more than 230] Babies ‘R’ Us stores; we’re in only 105 of these, and they plan to open another 100 locations—so we have expansion opportunities there as well as in malls.”

In addition to these proven growth vehicles, Merrill said Kiddie Kandids would consider acquisitions, although there are limited opportunities from existing formats. However, Kiddie Kandids will continue to evaluate other retail locations that would provide a good fit for store-within-store partnerships.