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The Consolidation Conundrum
How business mergers are impacting optical
by Erinn Morgan

Consolidation: It's a game of size whose outcome will affect an industry. Buying, selling, IPOs and, inevitably, increased competition affect the entire optical market. When did it begin? That's questionable. But people started to sit up and take notice when optical chains began to grow larger and stronger through mergers and acquisitions; when manufacturers initiated vertical integration into retail channels; and when optical manufacturers/distributors themselves started to grow through mergers and acquisitions. Even the smaller players who still hold the lion's share of optical market dollar volume--the independents--started to join forces to form multi-office practices.

How will the dust settle...when it finally does? How will the optical landscape look in five to 10 years once independents, chains, and distributors have played out their hands? Very different from how it appears today, say most industry experts.

Those companies and independent practitioners that have initiated intelligent, responsible changes in their businesses will move into the future successfully. Those who have merged, acquired and consolidated irresponsibly, or not reacted to market conditions at all, will at best merely survive.

"With all of the acquisitions and changes going on out there right now, I think that there's a kind of judgment day coming," says Gregory Segall, chairman, president, and CEO of Consolidated Vision Group, the parent company of Texas State Optical and America's Best, with more than 200 total locations.

THE EFFECTS: CHAIN CONSOLIDATION

Optical chains have been creating quite a ruckus with their seemingly daily announcements of acquisitions, mergers and IPOs. Actually, chain retailers have been gobbling up one another for a few years now, and some of the deals have been mammoth (i.e. Cole National's acquisition of Pearle Vision). Many say this trend has occurred as chain retailers look to get more points of entry in regional areas across the country.

"People saw opportunities to acquire chains with a strong regional presence to have a stronghold in those areas," says Brian Smith, president of Cole National.

In addition, as they grow doors across the country, chains gain a national edge to hold large managed care contracts. "Our strategy for growth is affected by the way managed care continues to flex its influence," says Nils Bonde-Henriksen, spokes-man for Sight Resource Corporation, the parent company for Cambridge Eye Doctors, Vision Plaza, Vision World, E.B. Brown, and Eyeglass Emporium. "By buying small regional chains, it gives us more distribution points to negotiate with when we go in and try to contract with an HMO." (On January 25, the company announced its purchase of Shawnee Optical, which has nine locations in Ohio and Pennsylvania.)

There's no question that many large chains have developed an appetite for growth and acquisition.

One frequently discussed purchase is National Vision Associates, Ltd.s' (NVAL) acquisition of Frame-n-Lens. After inking that deal, the company experienced stock market fluctuations when it went public on December 1 as Vista Eyecare Network (NASDAQ: VSTA).

And in at least one recent buy, the purchaser did not recognize 100 percent of the debt owed on frame accounts and several manufacturers lost money in the merger.

Says one major frame distributor, "there are always bumps in the road with consolidation, but surprises shouldn't be that great." Vista Eyecare Network has declined to comment.

Acquiring chains can also be challenged by managing formats that are different than their previous core business. "Cole was in a very different kind of business and all of a sudden they had to deal with the wholesale business selling to franchise businesses," says one major frame supplier.

Cole, in fact, has announced plans to invest $25 million in revising the Pearle operating model and to establish Pearle as a more autonomous division with its own management structure.

In addition to feeling the effects of the product transitions chains must make when acquiring another chain, manufacturers/distributors say they are also now dealing with fewer yet more powerful buyers. This situation creates new demands for them, as their product "eggs" are now in fewer baskets.

"Consolidation has hurt the wholesale business," says one major frame distributor. "For example, I have seen chains close without paying vendors for products that were never returned."

And when a major chain that does not do business with a certain vendor buys a chain that the vendor does do business with, chances are the vendor will be cut off in the new deal. "Last year two small chains were bought by a larger one, and between them we lost a half million dollars in sales a year," says an East Coast-based frame distributor.

VENDORS: THE SIZE FACTOR

The challenges faced by product companies in light of the proliferation of consolidation are made even tougher by the fact that there are a plethora of vendors, each with a wealth of product lines competing in the shrinking marketplace. "There is an overcapacity at the supply level," says Consolidated Vision's Segall. "There are so many brands."

"There's just too many vendors out there," says Mike Hundert, president of Rem, a frame distributor based in California. "And the market conditions are making it very difficult for distributors to do business. Some of these guys, especially the smaller ones, are going to get clobbered." Hundert also notes, however, that even though the current market situation places more pressure on product suppliers, many chain retailers value strong relationships with their vendors, and obviously have an interest in keeping them healthy.

Still, industry experts agree that it will be difficult for small suppliers and new suppliers to survive and grow in the current market conditions. Thus, many believe that the consolidation that has already begun on the supply side of the business will continue. "You will see more consolidation on the supplier side this year than on the retail side," says Mike Ferrara, CEO of Marine Optical Group.

In addition, "Companies will have to be a lot more efficient," says Claudio Gottardi, executive vice president of S�filo USA. "Only those who combine marketing and technology together will be successful."

"As these retailers continue to get bigger, their buying power becomes tremendous," adds Ferrara. "And the demand for 'A' brands gets bigger also. In the next five years, suppliers will really have an obligation on how to do business more efficiently. This will be driven by a more sophisticated buyer."

Many product suppliers also point to the consolidation that is occurring in the optical lab sector as an additional squeeze on business. "The consolidation of labs is a tough situation," says Ed Greene, president and CEO of Zeiss Optical in the United States. "There is a lot of power in the hands of a few players. It does create an easy way to address the American market, but it is a benefit that also has a big risk."

Some say that the consolidation taking place on the wholesale lab side has been healthy. "There is a lot of change of ownership because there is a need for incremental capital to remain competitive and play in the premium products game," says Chris Paddison, president of Essilor Labs of America, which currently has 65 labs nationwide.

A NEW MARKET: PROBLEMATIC FOR THE INDEPENDENT?

With all this change and growth on the chain retail side, many ask if this sector will grow in total market share compared with independent practitioners.

"The independents's market share, which is about 70 percent, may lag," says Segall. "And you may see chains jump up to 40 to 50 percent."

"I think the signs of the last couple of years point to the chains growing in market share," says Sight Resource's Bonde-Henrikson.

"Independents have certainly proven to provide certain factors of quality, but chains can provide this more consistently," says Smith. "We live in a fairly mobile society and as people and families move, they can experience this consistency wherever they go through optical chains."

Some also point to the group of older O.D.s--in their 50s and 60s and who will soon look to sell their practices and retire--as an area for potential market share growth for chains. "There will be a wave of O.D.s who will want to retire and may have no one to sell their practice to," says Segall. "This may occur over the next 10- to 15-year period. As the next generation of O.D.s come out of school, many of them will work for chains because they can't afford to buy a practice. They can make more money at a chain."

Segall says Consolidated Vision has filled all of its doctor positions and has a waiting list for future positions. "That didn't used to be the case," he adds.

THE INDEPENDENTS: HOW THEY ARE HOLDING STRONG

While many things--chain consolidation, increased competition, managed care, staffing problems--have put chinks in the armor of the independent practitioner segment of the marketplace, they as a group are holding strong in market share. And many are employing tactics to make sure this continues into the future. One of those tactics is, interestingly, consolidation.

"I don't believe that moving out in the next five to 10 years, you will see any less retail points of entry for independent practitioners," says Alan Cleinman, president of Cleinman Performance Partners, a business development and consulting firm specializing in the vision care industry. "But I do believe you will see a huge movement among the independents to consolidate.

"What we're seeing is one or more providers going into business with another provider," adds Cleinman. "For example, Dr. Jones is a very strong business-oriented professional, but Dr. Smith is very frustrated with staffing, computers, products, and other issues. The two go into business together and then Dr. Jones runs the business while Dr. Smith does what he wants--see patients. These become regional consolidated providers, and some have as many as a dozen offices joined together."

This kind of organization has increased power--in the areas of purchasing, managed care, employment and more--and has increased the ability to be competitive.

"As a result of the marketplace--and specifically because of managed care and the impact it has had on the bottom line--you need to have a multiple-doctor setting," says Allen Leck, president of Primary Eyecare Network, an affiliate of Omega Health Systems, which provides staff education, buying group abilities and other services to 750 independent optometry practices across the country. "It is difficult now to have a single-doctor setting."

Leck says he sees many more O.D.s forming partnerships with other O.D.s. And he also believes that this type of setting will help those O.D.s looking to retire to make their practice more valuable. "A lot of O.D.s thought that selling their practice would be their retirement fund," he says. "Now with all the competition from the chains, they are forced to look at how to continue to grow that practice to make it more profitable and more appealing for a young doctor to buy. If you have a multiple-doctor setting, it makes it much more valuable."

"If I were an O.D., age 62, with no retirement and looking to sell my practice as a means of funding that retirement, I might be a little concerned," says Cleinman. "These O.D.s will have a tough time selling their businesses under the ways in which they bought them. As long as they are creative and realistic, there are plenty of buyers out there."

And while many young doctors have the opportunity to go in with chains or HMOs and have a decent salary, set hours, etc., Leck says that "many still want to be entrepreneurs, have more control, their own practice, and may want to specialize in pediatrics or low vision."

In addition to the consolidation taking place in the independent O.D. arena, there is also some consolidation taking place among high-end independent opticians. Lens-Crafters has been successful with its launch of the Specttica store concept. And now there is some indication that a new company is trying to organize a group of multi-unit, high-end dispensers into a 30-store company that will file for public offering.

Thus, the overwhelming industry thought trend seems to be "power in numbers," as chains, manufacturers, distributors, independent O.D.s, opticians, and optical labs all move to consolidate and grow in strength.

Certainly, changes are on the horizon, and many industry experts agree that this change will reshape the optical industry. On the chain side, there will be fewer but more powerful organizations. And on the independent side--"In five to 10 years, you will find fewer owners, but not fewer points of delivery," says Cleinman.

"In five to 10 years, there's going to be a large segment of the market still held by the independent practitioner, but the independent practitioner is going to look different," predicts Leck.

The key, say most, is to grow responsibly and proactively. "The smart, progressive, proactive people will thrive in the marketplace," says Leck. "Over the next 10 years, being in a reactive mode probably won't be sufficient." EB