Franchises, the Good, Bad and Ugly
We have worked with a number of clients on franchise related issues. This experience has caused me to question whether entering into some franchises is the best business option for some entrepreneurs. The concept behind franchises is good. A successful business is replicated to insure success for the Franchisee and a new revenue stream for the Franchisor. Generally the franchisor business has developed a good business model, usually including trademarks and a proprietary system. They then look to grow that business by granting a license to use the business’s branded trademarks and system to individuals in return for an up front fee and a percentage of weekly gross income. The party who enters into this kind of business relationship, the Franchisee, usually is an individual who has been downsized from a good middle or upper management job or someone who has burned out from a fast paced, high paying job and now wants to find a second career in a new field. The one consistent factor here is that the person has a good sum of money to pay the up front franchise fee. This fee ranges from $10,000 to in excess of $200,000 depending on the value of the franchise, how long it has been in business and its success in the market.
The franchise concept seems ideal to an experienced and intelligent business person. The Franchisee will be supplied with a list of inventory to buy, suppliers, a list of equipment and a how to manual on running the business. Initial training is also provided. The Franchisee, not knowing the industry, would have a hard time developing these types of lists or developing a budget for the business. The initial training appears to help avoid the bane of any business owner, the inevitable learning curve and the costly mistakes that occur as a result of inexperience. The Franchisor gets a business partner who is motivated, financially sound and experienced in business if not experienced in the particular business field. This appears to be a win-win for the franchise business relationship.
However, our clients’ experience sometimes suggests otherwise. Franchisors hand out rose colored glasses with the initial franchise circulars and franchise agreements to the prospective Franchisees. The rosy glow of the relationship lasts at least until the excitement wears off because profits are not as strong as anticipated.
So what are the things that cause problems?
1. No Ownership Experience. While highly sophisticated in their jobs prior to becoming Franchisees, middle managers are not entrepreneurial by nature. That means that they have been good employees but don’t necessarily have the skill sets to make decisions for a business. It does not mean that they necessarily have the experience to monitor financials, interview and hire good employees, enforce policies key to the business or judge the quality of the work being done by employees. Many franchise owners find that, based on their past managerial experience, they want to manage instead of providing services personal. Therefore the business rests on the prior experience of the employees and not the knowledge and standards of the new owner.
2. No Prior Experience in the Industry. It is hard training any new staff member. It is near impossible to train staff if you have no prior industry experiences. In addition, it takes time for the Franchisee to discover things that he/she is doing wrong in the business without experience. This often results in a ticking time bomb. If the problem is a quality issue then that can translate to poor business growth. Bad service translates to no renewal business and no referrals. This means that the business can only grow based on acquiring new clients instead of growing the business through new client acquisition, referrals and return clients.
3. Inflated Initial License Fees. A national franchise which has an established business name in the Franchisee’s market and which continues to market its brand in the territory can be well worth the investment in the franchise. The problem is that many Franchisors are not known in the geographic area in which the Franchisee will operate. When this occurs the Franchisee pays for an established business plan but must also pay for educating the consumer about the franchise business in its geographic market. This can be very expensive. It involves a larger advertising budget than most companies of similar size would need. This problem is especially serious because the lack of an established name in the market both decreases cash flow and profits at the most important time in the business’ history, the beginning. It is during the business’ s beginning that many one time up front costs occur. We have seen many Franchisees overpay for the initial license fee because they fail to take this issue into consideration when analyzing the desirability of the franchise opportunity.
4. The Franchisor is obligated to do what? Most Franchise Agreements provide a healthy number of provisions for what the Franchisee must do during the franchise relationship. Unfortunately, it is hard to find any significant obligations on Franchisors in the franchise agreements once the business plan or system has been delivered to the Franchisee and training has been completed.
5. When bad economic times arrive or problems occur, will the Franchisor be there with you in the trenches? Sadly, our clients would tell you no. The Franchisor often does not have sufficient staff or sufficiently trained staff to provide help on collections or billing issues, provide insight into new business trends or train employees. This also means that if the law related to the industry changes, the Franchisor is likely not able to provide the type of education and operational assistance necessary to understand the law and to implement it into the day-to-day operations of the business.
The problem caused by all of the above deficiencies is that Franchisees often use their initial capital too quickly and can not thereafter grow the business or produce profits quickly enough to replenish the Franchisee’s funds. Also, if the Franchisee does not adequately penetrate the market in the business’s territory, the amount of the large initial fee is wasted. Further, the Franchisor may be tempted to place a second location too close to the territory in order to increase its profits, which further negatively affects the Franchisee’s opportunity. The Franchisor’s fixed business plan for the business model, based on regulations ironically to protect the Franchisee, also make it difficult to make changes in the market, technology changes or the economy generally. All of these factors make it increasingly difficult for the Franchisee to survive. These factors are also affected by the sheer length of the franchise agreement, most for 10 years. The length of the franchise agreement’s term makes it hard to downsize, change location or otherwise attempt to control new factors in the market. Since leases and franchise agreements are generally for different time periods, this can cause havoc for a Franchisee.
We understand the importance of limiting your business’s liability and have advised clients on how to handle franchise issues. For more information on franchises or how we can otherwise help you with your business generally, please contact us at (708) 848-0800.