Winmark: Business Overview

Surprisingly profitable and durable business model

In 1983, Martha Morris wanted to pursue her new interest and bought camping and backpacking equipment. However, she quickly realized she didn’t actually enjoy it. Shortly after, Martha tried to sell her equipment, attempting to do so by talking to shop owners. One of these retailers told her they didn’t sell used equipment.

Noticing there was no supply for her need, Martha decided to start Play it Again Sports. The idea was to build retail stores with a “garage sale-looking environment” to captivate franchisees who would like to sell used products.

In parallel, Ron Olson and Jeffrey Dahlberg started a consulting firm in 1986. Martha was one of the first customers they had. After noticing the success and potential of her idea, Ron and Jeffrey bought the rights for Play it Again Sports in 1988. This became Winmark’s first division, then called Grow Biz International.

By the year 2000, the company had opened multiple lines of franchises but was severely struggling financially. John Morgan took over as CEO and turned the business around. He sold the company’s corporate headquarters, three franchises’ rights and re-built the organizational structure, replacing most people. Winmark went from an $8.5 million loss in 1998 to consistently profitable after 2001. Morgan led Winmark until he stepped down in 2016, when Brett Heffes replaced him. Brett continues to hold his position as CEO of Winmark.

Business overview

Winmark is a franchisor focused on sustainability and small business formation. They ‘champion and guide’ entrepreneurs interested in operating one of their five resale franchises:

• Play it Again Sports (began in 1988): Buys and sells gently used and new sporting goods, equipment and accessories.

• Once Upon a child (1993): Buys and sells gently used children’s clothing, toys, furniture, equipment and accessories. The primary target is parents with children under 12 years.

• Music Go Around (1994): Buys and sells music instruments, both gently used and new, speakers, amplifiers, and music-related electronics.

• Plato’s Closet (1999): Buys and sells gently used teenagers’ clothing and accessories. The primary target is mostly teenage girls.

• Style Encore (2013): Buys and sells gently used women’s clothes, shoes, and accessories. The primary target is women between 20-50 years.

Each of these work by buying ‘gently used’ items from customers and re-selling them. People that sell the items can receive cash or a higher amount in credit store. Some of these franchises also sell online. On average, it is estimated that Plato’s Closet pays customers around 30%-40 of the price they’ll be selling an item at. The other franchises operate similarly.

Management is very selective of the people with whom they do business. Several requirements need to be met for a person to be considered as a potential operator. The company seeks franchisees who:

• Have a sufficient net worth. For example, to operate a Play it Again Sports store, operators are required to have a net worth of 400,000 dollars and 90-105k in liquid assets.

  “Play It Again Sports expects franchise candidates to have an approximate investment of $300,000 to $410,000 to open a store”

• Prior business experience.

• Intend to be integrally involved in managing the store. This implies operators cannot open one as a hobby. Rather, they need to run the store full time. At the same time, they are required to sign a non-compete agreement.

Winmark has partnerships with different businesses for each brand. When franchisees buy new products, a portion of them need to be bought from these set of partners. Nonetheless, the majority of the products sold are bought from customers.

Once Upon a Child, for instance, buys approx 30% of new products from 4 partners. MGO, 50% from 5 partners. No significant vendors in Plato’s Closet nor Style Encore. On the sports brand, no number mentioned.

John Morgan Shaping the Culture

John Morgan crafted Winmark’s brand and culture. When he sold his business to TCF, he asked for equity in exchange, for John considered TCF to be undervalued. After the stock did fantastically over the subsequent years, Morgan and his partner became very rich. Shortly thereafter, both began an investment firm. Morgan was soon called for a meeting with Grow Biz’ management and large shareholders. They wanted him to take over as CEO. John agreed, but on one condition:

“It wasn’t going to be groupthink. It was going to be my way or the highway”

Morgan recalls having found an absolute mess in Winmark. By 1998, the company had more than 1,200 franchises, but growth started slowing down, which is when the bleeding started. In 1999, revenue declined 32% and, after having 7.2M dollars in net income in the previous year, the company reported a loss of $8.5M. John Morgan’s employment agreement started in 1999 and, in the year 2000, Winmark had a loss of $350,000.

Once John took over, he did a complete turnaround. Grow Biz International was renamed as “Winmark”. Morgan shut down three lines of franchises the company previously offered, namely: (i) Computer Renaissance, computers resale; (ii) Retool, consistent of tools resale; (iii) It’s About Games, which was disposed and Winmark recorded an asset impairment of over $11 million. Computer Renaissance was sold for $3 million and Retool, 3 years after being acquired, dissolved. Moreover, John Morgan decided to sell Winmark’s headquarters. Koch Trucking bought the property for $3.5 million.

Prior to Morgan joining, the team had acquired the franchising rights of Plato’s Closet. As soon as John took over the firm, he realized the potential this franchise had and decided to bet heavily on it. As of 1999, Plato’s Closet had a total of 5 stores, which scaled to a couple hundreds in the subsequent 15 years. Morgan kept three other franchises: Play it Again Sports, Music Go Round, and Once Upon a Child.

In addition to all of this, John completely changed the business’ strategy. Grow Biz used to give franchises to whomever had the money to open one, independent of their capabilities. Furthermore, the majority of the company’s topline was generated by selling products to franchisees. Morgan decided to award franchises, instead of giving them away. Winmark started intensely screening for candidates and placed more emphasis in helping them thrive. At the same time, Winmark would no longer generate most of its sales by selling products to franchisees, but rather by charging a royalty fee.

When John Morgan was appointed CEO, he was awarded 600,000 options to buy stock at $5 per share, which would vest over the subsequent five years and expire in 2006 if unexercised. Morgan made full use of the options. Thereafter, he was awarded no more options and complemented this with continuous purchases of Wina’s shares in the open market. Throughout the years, John got to own 34% of Winmark’s equity in 2013, equivalent to over 1.7 million shares.

Another peculiarity this man had is that his compensation was the lowest among executives. In an interview, Morgan highlighted how he was aligning incentives between everyone within the company.

-Interviewer: Is your share-buying a slow way to take the company private?

Morgan: I want the company to be public. To motivate the employees, it has to be a public company. Stock options are the best way for them to grow their net worth.

-Interviewer: The Winmark March 2013 proxy disclosed that you and your top three managers all earned the exact same salary ($267,250) and exact same bonus ($267,250) for fiscal 2012. Why the same?

Morgan: You don’t do things just because you can. You do things because you have a reason to. And my reason to do this is that this motivates them. It works.

Winmark does not have an IR team and management do not do conference calls. Quarterly press releases and annual reports are as short as it gets. Hereafter, I will dive into:

• The Franchise Agreement

• Winmark’s historical financials

• Trends worth paying attention to

• How the business has evolved

• The closure of the leasing business

• Capital allocation policy

• Winmark’s current position and Brett’s vision