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Bilkem Chowderhead

As a middle-aged guy with the flexibility of a drafting desk and as a native Minnesotan who considers 40 degrees Fahrenheit to be t-shirt and shorts time and the flexibility of a drafting desk, Bikram Yoga, or “hot,” as in 105 degrees hot, yoga, is not a cup of tea I’ve fancied with any great enthusiasm. As an entrepreneur and small business/startup consultant, however, I’ve followed the business of Bikram Yoga with considerably more enthusiasm. Founded by Bikram Choudhury in 1972 (with American taxpayer money), Bikram Yoga has over the years grown to 320 studios across the country, most of them small businesses independently run, and become the most valuable yoga “product” in America.

Bikram Yoga owes its phenomenal success largely to the affiliate business relationships its founder, Mr. Choudhury, has established with the independent yoga entrepreneurs and small business owners that have expanded the practice across the States. Without having to invest much of anything in the way of marketing, product development, or operations . . . or even a valuable brand name . . . Mr. Choudhury was able to extract value from the relationships by requiring that all Bikram Yoga studio instructors be trained by him, at $10,500 a pop. As affiliates rather than franchisees, these small business entrepreneurs went out there and built the Bikram Yoga business and following, enabling Bikram Choudhury and his company to make millions (he owns an 8,000 square foot mansion in Beverly Hills and drives not one, not two, but dozens of Rolls Royces and Bentleys, each of them essentially as valuable as a house. In other words, the affiliate model was a perfect model for building a large business with few resources and a “brand” of little or no value.

But now, according to Forbes, Bikarm Choudhury wants to change the deal. He wants more money from the small business owners and entrepreneurs who built the continent-wide business because, well, because he can. And therein lies a valuable lesson and case study for small business owners and entrepreneurs who would either like to build a nation-wide business or would like to build a small business based on someone else’s property.

So how Bikram Yoga turned into Bilkem Yoga and Mr. Choudhury has proven himself to be a Chowderhead of the highest order is a long and complicated tale of smart business decisions being upended by plain old mustard-on-a-bun greed. And it’s a tale of a smart business person making his fortune on the hard work and investments of entrepreneurs and then, when the upside starting going up, reneging on the deal. And for the small business entrepreneurs who made Choudhury successful, it’s a cautionary tale of structuring a relationship contractually so that your business partner can’t and won’t whimsically restructure the relationship when your investment starts to pay off.

Bikram Choudhury, although he protests that he is not a businessperson, knew how to build Bikram Yoga into a big business over the decades using an affiliate, rather than a franchise, model. He would provide the intellectual property, they would provide the money and hard work to build studios across the country. Without investing much in branding, advertising, operations, or management, Choudhury was able to build a national network of Bikram Yoga studios and, in the process, make himself a millionaire many times over by training the instructors (the training part of the business rakes in almost $5 million a year for, get this, about four weeks of work).

And for 25 years, this affiliate model worked great for everybody involved. Entrepreneurs signed on, paid for the training, put up all the investment, opened studios, and steadily grew Bikram Yoga across the country, something Choudhury would never have been able to do based on the revenues of just a couple studios owned by himself.

When the time — or tipping point — came for Bikram Yoga (and all fitness fads will eventually have their 15 minutes of fame) in the early 2000′s, a network of studios and highly skilled trainers and entrepreneurs were in place all across the country to meet the sudden flash of customer demand.

But while affiliate marketing relationships significantly reduce the cost and risk of building a nation-wide business presence for the parent company, they also significantly reduce the potential upside for the parent company. The affiliates take on most of the risk and the work and receive very little marketing, operations, or supply help from the parent, but they, in return, get to capture most if not all of the upside if the business takes off.

There are really only two alternatives to an affiliate network: company-owned stores (or branches) and franchise relationships. Opening a network of 320 yoga studios fully owned by the parent company not only requires a vast amount of capital (initial capital investment in each studio: around $250,000), but significant competencies in marketing, branding, public relations, finance, and a multitude of others. Suffice it to say that opening 320 yoga studios owned and operated by Bikram Choudhury was not and would never be in the cards.

Franchise relationships are, in all essence, value trades. A franchiser brings great value to the franchisees: a valuable brand, fully scaled product development, advertising, marketing, branding, public relations, real estate management, construction management, and supply chain management. The entrepreneur “pays” for this value with initiation and licensing fees, usually a percentage of monthly revenues.

For instance, if you decide to open a McDonald’s restaurant, you are buying a brand that sells itself. McDonald’s spends considerable amounts of time and money developing and testing products, conducting market research, advertising, flakking the press, negotiating equipment and supply deals, training managers, and handling supply logistics. You, as a franchisee, are responsible for injecting capital into the business and staffing the business.

(Consider just the value of the McDonald’s brand, which Business Week calculates as the ninth most valuable global brand with a monetary value of $27 1/2 billion dollars. There are 31,000 McDonald’s restaurants worldwide, almost all of which operated by franchisees. Each restaurant, then, is getting about $900,000 of brand value from the business relationship. Yes, I know, I’m making some hyper-stupid assumptions and elisions here, but you get the picture of how franchisees are buying value.)

For all of the value that McDonald’s brings to your restaurant small business — including all of the real estate negotiation and construction management — you have to pay $45,000 at the outset of the franchise (usually 20 years) and pay them 12.5% of your revenues each month (that includes marketing and advertising costs).

Considering that “McDonald’s” pretty much sells itself with it’s 27 billion dollar brand, that’s not a bad deal.

Now, suppose you want to franchise with a national business that does not have the powerhouse branding that McDonald’s has, say, Carl’s Jr. You are clearly — sorry, Carl — buying into a brand of considerably — exponentially — less value than McDonald’s. Their advertising budget is only a fraction of McDonald’s advertising budget and, after the McCafe launch, their product development is light years behind.

Still, it’s a valuable brand and they, too, provide national media advertising, direct mail, promotions, product development, real estate negotiation, construction management, leasing management, legal help, operations, manager training, and supply chain management. All extremely valuable and extremely costly.

So you can have a Carl’s Jr. franchise at a slightly lower initiation fee ($35,000 — but remember, that includes a huge amount of legal and construction management work) and with a considerably lower royalty fee (about 4% versus McDonald’s 12.5%).

How about you trawl down the food chain even further to a real loser, say, Arthur Treacher’s Fish & Chips. If you haven’t heard of them, that’s okay. They really don’t advertise, market, or build their brand much. Back in the 1970′s, they were hot stuff and commercials on all three channels (remember when TV only had three channels?). Now, all the franchising company (PAT Franchising) offers is a tiny bit of advertising and promotions, supply chain management, manager training, and a relatively low value brand. All at the low, low price of a $30,000 initiation fee and 5% royalty on revenues.

Let’s do the comparison with McDonald’s with the 27.5 billion dollar brand. In 2006, Nathan’s Famous purchased the Arthur Treacher’s brand and all its intellectual property from PAT Franchising for . . . are you ready . . . $1,346, about the price of a business lunch at Del Frisco’s on Sixth Avenue. There are 35 Arthur Treacher’s restaurants (mostly in Ohio), so, if we do the same simple-minded math as we did for McDonald’s, they’re getting about thirty-eight bucks of brand value for their franchise fees.

So which is it? McDonald’s (at 12.5%), Carl’s Jr. (at 4%), or Arthur Treacher’s (at 5%)? You know why there’s only 35 Arthur Treacher’s restaurants? Because the franchise deal is a pretty bum deal when you think about it (however, the average startup investment for an Arthur Treacher’s restaurant is about $300,000 whereas the average initial investment cost of a Carl’s Jr. restaurant is somewhere around a million and a half dollars — limited choice of location as well as restaurant size have much to do with the difference).

Do you get the picture? Do you see Bikram Choudhury’s dilemma when, almost thirty years ago, he wanted to build a national Bikram Yoga studio presence?

He can’t open up his own chain of Bikram Yoga studios because, with an average startup investment clocking in at around $250,000 in 2009 dollars, he just couldn’t afford it. (Today, his company has the resources to open maybe 30 or 40 studios including the cost of ramping up his human resources to manage the larger, more bloated business.)

What about a franchise? Turn the clock back twenty years (even ten years). What does Choudhury have to offer that could possibly justify initiation and royalty fees? All he had was 26 yoga poses, his name (which was unknown for most of the last 30 years), and this whole “do it hot” nonsense.

In other words, 20 years ago, “Bikram Yoga” had zero value to potential franchisees. Especially since the national organization is doing little or nothing in terms of branding — even the branding is largely offloaded to the small business owners. Offering no brand value, no advertising, no operational help, no supply chain management, no management training, no nothing whatsoever, Bikram Yoga did not have franchising as an available strategy.

So Choudhury sold to his affiliates what does have value: Bikram Yoga instructor training, the only requirement you have to use the name and the techniques as a Bikram Yoga affiliate.

Fast forward 20 years and Bikram Yoga is making some serious money. The latest exercise “fad” switches to mind-body exercise in the early 2000′s and yoga makes a lot of people rich, such as DVD maker Gaiman. Now, with a strong differentiator (doing yoga in 105 degree heat) that makes it look and feel more like actual fitness (in that you sweat your buns off), Bikram Yoga studios, which have a fully built national presence and experienced instructors, is set up to grow quickly off the mind-body exercise fad.

Which it does.

In this climate, without much effort on Choudhury’s part, “Bikram Yoga” becomes valuable as a brand. Like McDonald’s or Carl’s Jr., it “sells itself,” so pasting it on your storefront or Yellow Pages ads brings in revenues.

And who is capturing almost all that value?

The affiliates.

Fast forward to 2009 and Bikram Yoga is still growing strong. It’s made Bikram Choudhury incredibly wealthy, but most of the “brand value” flows to the affiliates. That, in a nutshell, is the problem with the affiliate model. It’s a great way to take intellectual property (such as 26 yoga poses, your name, and the thermostat set to three digits) and, without much or any effort on your part, make it into a nationwide business throwing money into your bank account in enviable amounts. It’s great for building up a business on almost nothing with almost no competencies, because you can attract entrepreneurs with its low entry cost but potentially generous upside which those entrepreneurs get to keep entirely. However, it sucks more than a little when the business takes off, because so much of the value flows to the affiliates that the parent.

So Choudhury wants to change the deal, which is something any businessperson should approach with trepidation. He recently sent out a franchise contract to all his affiliates and demanded that they sign it or lose the right to use the name or the techniques (which, I gather, includes the 105 degree heat). Existing affiliates must now pay a royalty fee of 1% of revenues and an advertising/marketing fee of $400 per month while new studios will have to cough up a royalty fee of 5% (or $1,000, whichever is higher), the advertising costs, and a $10,000 start-up fee.

And that’s where the Bilkem comes in. Is it fair of Choudhury to change the deal on the people who made him successful? Remember, it was their capital, hard work, and marketing that built his wealth and set him up in style in Beverly Hills; through his affiliate relationships with these entrepreneurs, he was able to build a lucrative nationwide business and brand without putting much of anything into it.

And he’s not offering anything of value now, except for the intellectual property. Remember, when you sign up with Carl’s Jr., you’re paying for supply chain management, national advertising, top-level branding, management training, operations help, and real estate/construction expertise. All Mr. Choudhury is offering for his 5% royalty (1% for existing studios) is, well, his name and 26 poses. Which is why nearly every existing Bikram Yoga studio is balking at the new franchise agreement.

But think about how much money is really involved in that 1% royalty — that’s where the Chowderhead part comes in. Let’s say a studio is raking in around $25,000 a month (which is what a successful yoga studio should do). 1% is $250 a month. That’s not bad. Why should anyone complain about paying $250 to $300 a month?

But if it’s not much for the studios, it’s even less for Choudhury. There are 350 Bikram Yoga studios. Let’s say, generously, that half decide to sign the royalty agreement while others simply go off on their own. That’s 175 studios paying $250 a month in royalties, or $43,750 a month or $525,000 a year.

The cost of that $525,000 a year? A mountain of bad press and 175 new, established competitors with loyal customers, local marketing competencies, and strong community involvement that you didn’t have last week.

Bikram Choudhury, I will be the first to say, has every right to charge for his intellectual property and extract as much value as possible from it, both the poses he’s copyrighted and the name he’s trademarked. But just because he can doesn’t mean it’s a good business decision that he should.

A good rule of customer service is to never give your customers a reason to check out the competition — inertia is the principal force of customer loyalty. In the same way, it is never a good idea to turn your business partners into business competitors. They know too much about you and, in the case of Bikram Yoga, they are the ones with all the business sense and local competencies. Is it worth turning a business partner into a fierce competitor over a couple hundred dollars a month?

It’s clear that the best course for Choudhury would have been to maintain his loyalty to the small business entrepreneurs that made him wealthy — he wouldn’t have the dozens of Bentley’s and Rolls Royce’s had those entrepreneurs opened some other type of yoga studio — while at the same time finding more ways to realize revenue from those studios (by selling product lines, say). However, for new studios, he could and should extract the value from his intellectual property by charging initiation, royalty, and advertising fees. If any current affiliate opens a new studio, that studio would be subject to the franchising fees.

Instead, he’s getting one bad press story after another and, it seems, most of his current affiliates are going to bolt out of the deal.

In business as in life, character counts. And loyalty and constancy towards those who make you successful in business is perhaps the most valuable way to profit from business relationships.

From the affiliate side, it helps to remember the Bikram Yoga story and that the parent company may and probably will change the deal if the brand gains an appreciable value. The affiliate relationship should be structured just like a franchise relationship in that there is a term (20 years is the most common) and a renewal clause allowing the relationship to continue for at least the first renewal in the same terms as the first (in other words, as an affiliate rather than a franchise relationship). Everyone who does a deal, in other words, based on “understandings” and a handshake deserves what they get.

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