Tim Hortons’ extra-large trouble trouble - Macleans.ca

Tim Hortons’ extra-large trouble trouble

The bitter battle inside the country’s favourite coffee shop

by

THE CANADIAN PRESS/Chris Young

On a recent Thursday morning, as thousands of Canadian coffee lovers waited in line for their daily fix of Tim Hortons, the company’s head office unveiled its latest quarterly earnings report. The figures confirmed—yet again—that when your brand is the closest thing to a national religion, filling the collection plate is never a problem.

Total revenue: $639.9 million. Total profit: $94.1 million.

That same morning, Aug. 12, Hortons executives made another lucrative announcement: the company had just sold its 50 per cent stake in Maidstone, the Brantford, Ont., bakery that mass-produces donuts and muffins for every “Tim’s” in the country. Originally launched as a joint venture in 2001, Maidstone now belongs to the Swiss food giant Aryzta AG, which paid a whopping $475 million for Hortons’ half of the operation (and has agreed to continue supplying the chain with fritters and biscuits until at least 2016).

For Tim’s shareholders, the deal is sweeter than a honey dip, as the company promised to pour every penny back into their pockets. For the rest of Hortons’ “shareholders”—those countless loyal customers whose ownership is strictly sentimental—the bottom line is this: your chocolate Timbit, a scrumptious ball of Canadiana, is now produced by a company from Switzerland. And it is still “Always Fresh” (i.e., frozen and reheated).

Tim’s regulars may have a hard time swallowing the news that their maple dip is no longer produced under the Maple Leaf. As national symbols go, a Hortons donut is second only to a Hortons coffee. But Timmy’s selling baked goods from a freezer? That’s standard operating procedure, and has been for quite some time.

Yes, it was certainly a scandal back in 2003, when Hortons co-founder Ron Joyce confirmed the truth: that the company he built (and had recently left) replaced its in-store deep fryers with frozen globs of dough trucked in from a factory. “This is not a philosophy that I would have embraced if I still owned the company,” he famously boasted. One Hortons spokeswoman, convinced that she could stop the unflattering headlines, famously told a reporter that “until I confirm or deny anything, it simply doesn’t exist.”

It did exist, of course. And the backlash was swift. (Joyce’s words were especially damaging. “I’ve tried them,” he said of the new donuts. “And they’re certainly not the same.”) In time, though, most people eventually forgot—or simply stopped caring—where their honey crullers came from. Truth be told, many customers still have no idea that the donuts on display have to be defrosted.

But that is about to change. In the coming weeks, Tim’s devoted disciples will receive a very fresh reminder about just how much their donuts have evolved. Hortons’ historic decision to go frozen is now at the heart of a proposed $1.95-billion class action lawsuit that has exposed a bitter—and very personal—battle inside the country’s favourite coffee shop. Scheduled for a hearing in November, the high-stakes case pits store owners against senior executives, store owners versus each other, and even relative against relative. And no matter how many spokespeople try to control the message, the spat is sure to have some patrons pining for the old days, when the smell of deep-fried Dutchies hung in the air at their local shop.

Officially, the case is about a few disgruntled franchisees who claim their profits are shrinking because the company, via Maidstone, is charging “inflated” prices for those frozen goodies. But flip through the court file—through thousands of pages of exhibits and affidavits—and a much deeper storyline emerges: an old-fashioned power struggle between those who are still loyal to Ron Joyce, and those who replaced him at the top.

The lead plaintiff is a Burlington, Ont., store owner named Archibald Jollymore, Joyce’s former executive vice-president (and his cousin). One of Jollymore’s primary targets is Paul D. House, Joyce’s successor as president (and a man who garnered zero praise in Joyce’s recent autobiography). Both men have different philosophies, to say the least. House and his colleagues claim Jollymore is a poor businessman, and if his Hortons outlet is truly losing money, it has nothing to do with frozen products. Jollymore claims he has been “intimidated and bullied” by head office, and that the executive chairman personally threatened his life. “If I had a gun,” House allegedly said, “I’d shoot the bastard.”

Stuck in the middle of this donut war are hundreds of other Tim’s operators who are anxious to see the whole thing tossed out of court. Many have submitted sworn affidavits of their own, insisting that the Always Fresh system was “a welcome transition” and a “necessary evolution.” A core group of “concerned franchisees” even launched a password-protected website that urges others to oppose the claim. Their biggest concern? That their bottom lines will be disclosed in court for everyone to see. “How comfortable are you sharing your profitability with the media?” the website asks. “Do we want the press reporting about the Tim Hortons’ brand in a negative way?”

Among those furious over the lawsuit is Graham Oliver, who owns five Hortons stores in the Kitchener, Ont., area (and also happens to be Joyce’s nephew). In an affidavit obtained by Maclean’s, Oliver says if the public ever discovered how much store owners earn—“coupled with complaints that profit margins are not great enough”—it would “create an image that franchisees are wealthy, greedy people.”

As for that other image—frozen fritters in the back of a transport truck—it gets plenty of mention in the court file. One owner who supports the suit (and, like Jollymore, was a senior executive under Joyce) goes so far as to claim that some of the new donuts are “14.3 per cent” smaller than the originals. “I only have this information,” Cyril Garland wrote, “because having noticed what seemed to me to be smaller donuts, I instructed my bakers to periodically weigh each donut in randomly selected boxes as they unpacked them.”

Tim Horton opened his first coffee shop in 1964, and half a century later the company’s place in the Canadian landscape is the stuff of business school textbooks.

An all-star defenceman with the Toronto Maple Leafs, Horton was the public face of the original concept, a hockey icon whose name alone could reel in customers. But his behind-the-scenes partner, Ronald V. Joyce, was the man with the master plan.

During those early years—while Horton was patrolling the blue line, and Joyce was working night shifts frying batter—the company grew from that single store in Hamilton to three dozen restaurants. Later, when Horton was killed in a tragic car crash, Joyce bought out his partner’s widow and kept on expanding. Today, there are more than 3,000 Tim Hortons outlets from coast to coast, and nearly 600 south of the border. And every morning, millions of Canadians reaffirm the famous slogan: “You’ve always got time . . . ”

Like every fast-food chain, Tim’s business model is built around franchisees. Every store owner pays the company a hefty start-up fee—close to half a million dollars—plus a percentage of yearly sales to cover rent, royalties and advertising. Owners are also obligated to buy their supplies from the company, but after that, the profits are theirs. As Joyce wrote in Always Fresh, his 2006 autobiography: “If there was ever a sure thing, owning a Tim Hortons franchise was it.”

Things worked out quite well for Joyce, too (from a financial standpoint, at least). In 1995, he famously sold his beloved company to Wendy’s, the U.S. burger chain, in a transaction worth $600 million. But despite being appointed senior chairman of Hortons and given a seat on Wendy’s board of directors, he soon came to regret the deal. Convinced that Wendy’s was “poorly managed,” Joyce clashed with fellow board members so often that he eventually stopped attending the meetings. Finally, in 2001, Hortons’ co-founder walked away for good, selling every last one of his shares for US$250 million.

By then, Joyce’s successors—men he had personally hired and mentored—were in the process of implementing a drastic change.

For decades, every Hortons donut was made from scratch in the back of each store, the product of professional bakers toiling alongside bags of flour and vats of grease. Each ring of dough was individually rolled, deep-fried and, depending on the type, dipped in chocolate sauce or stuffed with strawberry filling. Stocking the racks in the front of the store meant an eight-hour shift in the back, and at most restaurants, there were two bake cycles: one overnight, one during the day.

It was all part of the early Hortons appeal: the taste of fresh coffee and the aroma of fresh donuts.

For franchisees, though, it wasn’t always so romantic. A decent baker was hard to find and expensive to employ, and on those nights when they called in sick, owners had no choice but to crawl out of bed and take their place in the kitchen.

Consistency was also a problem (a walnut crunch at one shop could be double the size of a walnut crunch at another), while waste was an even bigger worry. If the apple fritters didn’t sell, they’d end up in the trash—along with all the money spent to make them. (The opposite was true, too. If a store ran out of vanilla dips, there was no quick way to stock up, resulting in lost sales.)

By the late 1990s, after endless complaints from store owners (and after Joyce sold out), Hortons executives began searching for a more efficient alternative to scratch baking. Their research took them to Europe, where some manufacturers had perfected the so-called “par-bake” method, in which goods are 95 per cent prepared, flash-frozen, and then later reheated in an oven. In July 2000, Hortons presented the idea—and some samples—to franchisees at an annual convention, and a month later they received the go-ahead from the Wendy’s board to negotiate the joint venture that would lead to the Maidstone factory in Brantford.

When the plan was publicly announced in March 2001, there was little talk about frozen donuts. Instead, Paul House, the new man in charge, mused about drive-through customers buying par-baked baguettes and loaves of bread. “We think it’s got a huge upside,” he said at the time.

Every store owner knew the real “upside”: their grease fryers and bake tables would soon be replaced with walk-in freezers and, to quote Arch Jollymore, a “special microwave-convection oven.”

A few times a year, Hortons executives meet behind closed doors with the “Advisory Board,” a group of franchisees elected from across the country. They discuss all sorts of issues, from leaky cups to the cost of cream. In June 2001, the main topic of conversation was the new “par-bake” initiative, and head office assured everyone that work was being done “to identify and develop solutions to all of the issues involved,” including design, distribution and “people/media plans.”

But for some franchisees, limiting bad publicity was the least of their concerns. They were far more worried that the frozen donuts would take a bite out of their profits—for reasons unrelated to consumer backlash.

One of those distressed owners was Cyril Garland, the company’s former vice-president of finance. After retiring in 1998, he purchased two outlets in Brampton, Ont., and, for a while, maintained “excellent relationships” with his former management colleagues, including House and Donald Schroeder, the current president and CEO. (All three men had memberships at the exclusive Griffith Island Hunt Club in Wiarton, Ont.)

In 2003, during one of their many hunting trips, Garland voiced his irritation to House, telling his former boss that the par-bake system had cost his stores tens of thousands of dollars in lost profits. Why? Because buying frozen donuts from Hortons, via Maidstone, was far more expensive than what it cost to bake them in-store. As Garland would later write in a sworn affidavit: “Although, in the end, I believe that the quality of our baked goods is degraded under the Always Fresh system compared to what it was under full baking, I have opposed the Always Fresh conversion only (and consistently) on the basis of the associated increased food costs.”

Depending on which court document is accurate, a franchisee used to spend somewhere between six and nine cents to produce a single, unfinished donut (i.e., before icing, glazing, etc.). With Always Fresh, that cost has climbed to between 17 and 20 cents. (According to Hortons, the precise price is 17.9 cents.) That may not seem like a big jump, but add up all those maple dips and toasted coconuts, and Garland says it’s enough to erode his profit margins by up to 3.5 per cent. In 2004, he claims, the bottom line at one of his stores was down more than $57,000.

Garland wasn’t alone. Jollymore—who also purchased two Hortons restaurants after retiring in 1994—noticed a similar drop in profits. So did his wife, Anne, who at the time controlled two stores of her own. In one affidavit, Jollymore says his business was losing so much cash that he was left with no choice but “to eliminate or reduce free product donations to charities, school fundraisers and community events.”

An engineer by trade, Jollymore joined his cousin’s company in 1977 and rose through the ranks to executive vice-president, second only to Joyce himself. As Joyce recalls in his book, Jollymore was one of his trusted advisers, and was with him in a Florida hotel suite in 1990 when then-NHL president John Ziegler broke the bad news that Hamilton would not be awarded a franchise. On the “Acknowledgements” page, Jollymore is one of the first people Joyce thanks.

Like Garland, Jollymore was soon butting heads with the executives who took his cousin’s place. At the heart of his beef is an allegation that Paul House assured franchisees that the cost of the frozen donuts would not exceed 12 cents apiece, and that any price increase would soon be offset by less waste, increased sales, and most of all, reduced labour costs. With the new ovens, after all, any employee—and not just a well-paid baker—can produce a batch of Timbits in a matter of minutes.

According to Jollymore, though, he and a number of other franchisees were “surprised and angry” to learn that the true cost of an Always Fresh donut was much higher. He complained to management. He complained to his local member of the Advisory Board, Miles Mattatall (a Hamilton franchisee whose family owns 14 stores). And he “advised Don Schroeder that many store owners were concerned and angry about being lied to.”

Nothing changed, according to Jollymore. He says that when Wendy’s took the company public in 2006, the Hortons brass focused even more attention on boosting shareholder value—“by marginalizing the franchisee.” As Jollymore later wrote: “The role of leadership is to develop strategies to increase top line growth in profits while ensuring the margins of franchisees are maintained. It takes thoughtful leadership to do both.”

In 2008, the Jollymores hired a lawyer.

Their lawsuit, which has yet to be certified as a class action or tested in court, attempts to recoup nearly $2 billion on behalf of every franchisee in the chain. Their statement of claim focuses on the infamous switch to frozen products, but it also demands damages for “the imposition of the lunch menu,” which—though extremely popular—has allegedly earned store owners “a minimal profit, and in some cases no profit at all.” (Simply put, Jollymore claims that Hortons “forces” franchisees to buy chili, soup and sandwich buns from head office, and then sell them back to customers at prices that are essentially break-even.)

After filing the suit, Jollymore wrote an open letter to his fellow store owners. “One of the unique aspects of the original Tim Hortons culture was the deep trust we placed in management to look after our best interests to enable us to prosper,” it reads. “What management priorities have been evident since the Always Fresh conversion?”
Anyone who has ever waited in line for a Hortons double-double has thought the same thing: “This place is a licence to print cash.” Indeed, with a 43 per cent share of the “quick-service restaurant” market in Canada—and annual revenue of more than $2 billion—Tim’s is an unlikely scene for a petty squabble over profits. But if the Jollymores’ lawsuit has revealed anything, it’s that some store owners, even those who oppose the claim, don’t always see eye to eye with the company.

In August 2008, two months after the case was launched, the board of franchisees invited Jollymore to discuss his concerns. According to his recollection, laid out in court documents, “most of the Advisory Board members at the meeting agreed that the erosion of franchisees’ margins was a problem,” and that some “acknowledged that they felt intimidated and bullied” by management.

Miles Mattatall, the Hamilton board member, sent a follow-up email to franchisees. He said the sit-down with Jollymore, who “has the same goals that we all do,” sparked a separate meeting with executives at TDL (Hortons’ corporate name). “We addressed many concerns including profitability and respect,” he wrote. “I am very optimistic that ‘change’ is to occur. I do believe TDL have gotten a strong message of discontent and that there has to be progress on two major issues . . . profitability and working relationship between TDL and the Franchise Group.”

Two months later, though, Mattatall and almost everyone else on the Advisory Board hired a lawyer of their own. They had decided that the Jollymores’ lawsuit—and not anyone at head office—was the real threat to their bottom lines. Claiming to speak on behalf of more than 300 store owners, they asked a judge to grant them intervenor status so they could argue against certifying the class action. The bulk of their evidence was provided by Joyce’s nephew, Graham Oliver.

“I do not agree with many of the material allegations and claims advanced by the plaintiffs. In fact, they are patently wrong and cannot be supported,” he wrote in one affidavit. “The plaintiffs also know that their claim is without merit, and that whatever their motivations for deciding to commence these proceedings, they are not based upon a bona fide belief in the claim as framed.” He added later: “Negative publicity has the potential of tainting the public image of the Tim Hortons brand, which is vital to our business.”

In November 2008, an Ontario judge denied the group’s request to intervene. As with all class action lawsuits, he ruled that potential class members can always opt out.

But for the concerned franchisees—and the company—a much bigger legal blow was yet to come.

Last year, lawyers for TDL asked Jollymore to consent to a sealing order on some of the documents the company plans to file as part of its defence, including detailed baking manuals and “highly confidential and competitively sensitive financial and business data such as profit margins and sales information.” Jollymore agreed to a partial sealing order, but insisted that some of the files—including the Always Fresh production manual—be made public.

Jeff O’Rourke, a senior finance official at the company, was stunned. In his own affidavit, he insisted that if the documents were disclosed, competitors would be able to pinpoint untapped markets and maybe even introduce their own par-bake infrastructure. “I have a great deal of difficulty in understanding why the plaintiffs, who are current franchisees, could conceivably want this information to be on the public record and available to Tim Hortons’ competitors,” he wrote.

Justice George Strathy wasn’t convinced. “The information described as ‘trade secrets’ is of the most general nature and at the very lowest level of ‘secrecy,’ ” he ruled in February. In fact, he said if a competitor wanted to copy Hortons’ par-bake style, it “would not likely need to know that you must bake a frozen lump of ingredients for a particular length of time at a particular temperature in order to a make a muffin.” Motion denied.

Hortons’ lawyers have yet to file those sensitive sales figures in court, but they must hand them over before Nov. 29, when Justice Strathy is scheduled to hear more motions from both sides. Jollymore will ask that the class action be certified; Hortons will request a summary judgment, arguing that the claim is baseless and should be thrown out.

Whatever happens, the evidence filed so far—enough to fill two banker’s boxes—has certainly taken a bit of the glaze off Hortons’ iconic image.

Cyril Garland claims that the company has resorted to “harassment” and issued repeated “threats and reprisals.” Hortons has already declined to renew the licence on one of his stores and “other franchisees are, quite rightly, fearful of the same consequence should they express any sort of adverse opinion.” Arch Jollymore has endured even worse (if the evidence is accurate). It was during an Advisory Board gathering in July 2008, right after he filed his suit, that he claims Paul House uttered his infamous threat: “If I had a gun, I’d shoot the bastard.” Jollymore also claims that a Toronto franchisee recently “suggested that I should be caused physical harm” for forcing owners to reveal their profit margins.

For the record, House has authored his own affidavit, but it is among thousands of pages of evidence that, like the profit margins, have yet to be filed by Tim Hortons.
In the meantime, the main players aren’t talking. Garland and Jollymore declined to be interviewed for this article. So did Graham Oliver and most of the other “concerned franchisees.” Those who did speak were brief. “I can only say that the Always Fresh system improved our profitability and has made our life much easier,” says Brent Gabbani, an owner from New Liskeard, Ont. Miles Mattatall—the Advisory Board member who wrote that Jollymore “has the same goals that we all do”—says he does “not know of any franchisee” who want to go back to the scratch baking days. “I personally have a great working relationship with TDL,” he told Maclean’s in an email. “And if I could buy more restaurants, I would.”

Head office isn’t granting interviews, either. David Morelli, Hortons’ director of public affairs, said the company will “politely decline” to comment while the case is still before the courts. However, Tim’s side of the story is laid bare in a publicly disclosed affidavit authored by David Clanachan, a long-time executive who oversaw the Always Fresh conversion.

“I truly believe that anyone with an appreciation of the Tim Hortons business model and the facts will conclude that the claim is completely baseless,” Clanachan wrote. “It is unsupported and unsupportable by the actual facts.”

Clanachan says every store owner—with the exception of Garland and Jollymore—understands that although the price of the frozen donuts are higher, franchisees have benefited from the convenience and the obvious labour savings. “Always Fresh Baking was and remains a business and economic success for every reasonably diligent franchisee,” he wrote. “The store margins have not been hurt by Always Fresh Baking. In fact, the margins are the same or better.” (Clanachan also denies that he or House ever told the owners that the new price of an unfinished donut would not exceed 12 cents.)

So why is Garland so adamant that the opposite is true? He is “an embittered franchisee” with “an unremittingly bad attitude,” Clanachan says. “We simply hear him out or read his memos and as politely as we can register disagreement and move on. Garland has major blind spots but he is not a stupid man and I am sure the situation is as frustrating to him as it is to us.”

And Jollymore? “As to why (if it is true) Jollymore hasn’t achieved labour savings when the average Ontario store owner has been able to, I can only say that it is likely that it stems from his abilities as a manager and a failure to follow the training provided with the necessary discipline,” he wrote.

Clanachan also addresses the issue that matters most to customers: the quality of the current donuts. Jollymore claims that the frozen versions have “a shorter shelf life,” and some do “not have the same aroma or taste.” Says Clanachan: “Our experience does not bear out this assertion.” To the contrary, he says Hortons has “received more positive comments about the aromas in the stores since Always Fresh Baking, since product is cooked more often.”

One man would certainly disagree: Ron Joyce. In his book, the Hortons founder writes that although the frozen donuts “have improved greatly” since they were first introduced, “they will never be as good as the fresh product we prepared completely in the stores.”

Near the end of his autobiography, Joyce also seems to foreshadow the current legal battle. “Since my departure in January 2001, senior management at Tim Hortons has begun altering its relationship with franchise owners by placing pressure on their margins,” he wrote. “When I owned the company, the number one customer of TDL was the restaurant owner. They were the backbone of the company; they were what made the system work. They are on the front lines, dealing face to face with the customer, and are therefore integral to the company’s success. Any change to that could have dramatic ramifications for the company in the long run.”

Like his cousin, Joyce declined an interview request. But Aileen O’Rafferty, the president of his charitable foundation, did pass along this message: “He still strongly believes in that statement and stands by it today.”