Franchisors Need Balanced Approach to Recession

For most of us, the current global economic crisis is like nothing that we have ever seen. The combination of high oil and food prices, the sub-prime meltdown, the collapse of large financial institutions, the sharp decline in home values, the avalanche of foreclosures, increased unemployment and highly restrictive credit has proven to be disastrous, and none of us can be sure how long this will last.

In the face of this deepening recession, we find ourselves hoping that franchisors will respond very differently to the current situation than in years past.

Three previous downturns come to mind:

1. The 1979 energy crisis and recession, which was fueled by a spike in oil prices following the Iranian Revolution and exacerbated by a tight monetary policy in the United States designed to control inflation,
2. The manufacturing slump in the early 1990s, as industrial production and manufacturing trade waned, and
3. The relatively mild contraction in the North American economy from 2001 to 2003, which resulted from the collapse of the dot-com bubble, the September 11th attacks, and major accounting scandals.

How have franchisors dealt with these recessions? In our experience, franchisors generally have been reactive, responding after the fact to the inevitable wave of franchisees who have suffered from declining sales and profits. This has resulted, predictably, in the loss of franchisee locations and franchisor market share.

We urge franchisors to take a different approach to these challenges this time around.  We offer the following suggestions to create a different paradigm:

• Avoid unilateralism. Reach out early to the franchisee community and jointly develop a protocol for dealing with the adversity of declining spendable dollars. Do not make pronouncements. Take advantage of the collective entrepreneurial and operational experience of the franchisee community. Work collaboratively with the system's franchisee association or advisory council.

• Resist the temptation to address the problem by imposing mandatory deep discounting.  While such an approach might well serve to increase traffic, it may also make the franchisees insolvent.  Franchisors feed from the top line of the franchisee's income statement.  It is the franchisee's bottom line, however, that should be as much of a concern to the franchisor as it is to the franchisee.

• Consider extending development schedule deadlines in area development agreements where the absence of financing might otherwise prove to be prohibitive in the area developer franchisee's efforts to open new locations.

• Temper the urge to squeeze out franchisees whose sales fall below system-wide medians, but who otherwise make a good faith attempt to comply with system standards.

• Seek additional sources of financing for both prospective and existing franchisees, which will facilitate higher sales and provide the means for franchisees to reinvest in the system by establishing additional locations. Offer to guarantee, in whole or in part, both financing and leases for franchisees.

• Pledge to abstain from seeking or taking payments from vendors and suppliers, so that the savings can be passed along to franchisees.  Ensure that the franchisees pay no more than fair market value for the goods and services used in the business.

• Consider that even franchisees making a good faith attempt to comply with their obligations may fall into arrears on their royalty and advertising fund payments.  Enter into sensible workout arrangements with these franchisees. In the current financial environment, simply adding the burden of deferred payments on top of a problematic royalty and ad fund fee structure is unlikely to solve the problem; such an approach is akin to cutting off the top of a dandelion.

• Provide a competitive advantage to the system by supplementing the advertising funds beyond those raised through assessments on franchisees. Think of this as an investment, rather than an expense.

• Reduce fees associated with renewals and the purchase of additional franchise units, to incentivize franchisees to remain and expand their investment in the system.

By learning from past mistakes, it is our hope that franchisors can work together with franchisees to collectively withstand the current financial maelstrom and emerge stronger.