Franchisee Failure

I've often generalized the 2 major causes of business failure as: Lack of Knowledge, Lack of Capital. Richard Gibson, a Wall Street Journal staff reporter has expanded on the list as it applies specifically to franchising.

  1. Undercapitalization. As I always say "It will cost twice as much, and take twice as long, plan accordingly".The article accurately states:
    1. Insufficient funding is a prescription for business failure.
    2. Unrealistic optimism can be a recipe for disaster.
    3. Weathering unexpected situations without a financial cushion can be problematic even for an established franchise.
    4. Would-be franchisees should assume that they will lose money for the first couple of years, and prepare accordingly.  
  2. Poor Management Skills.  You must have it, obtain it, or hire it.
  3. Failure to Follow the System. Franchises aren't designed for the independent minded.
  4. Poor Fit between Zee & Zor. Like a marriage, you want to pick the right business partner.
  5. Inept Franchisor. The article states:
    1. Aggresive expansion can stretch a system and short-change franchisees.
    2. Avoid overzealous brokers and consultants selling concepts.
    3. Be careful of Inexperienced franchisors

Some good tips from the Wall Street Journal, and certainly 5 key areas which every prospective franchisee should closely evaluate as part of their due diligence in becoming a franchisee.

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Believe & Succeed,DaleFranSynergy, Inc.Synergizing Franchising!

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Comments

Richard Gibson re Franchise Failure

At least Richard Gibson admits in this article that occasionally it is the franchisor who is responsible for the franchisee's failure!

I think that these business writers could go a little farther to acknowledge that franchisees who make the entire investment of labor and capital in the unit that wears the brand name generally do their very best to make their businesses a success. It is they, and not the franchisor, who bears the entire risk of the failure of the franchised unit. It is the franchisees who work the long hours for little pay or no pay to try to get to break even on the estimates provided by the franchisors.

As always, Richard Gibson writes an excellent article from the middle ground between the franchisor and the franchisee.

Under-capitalization

Read between the lines:

A franchise is a "proven system" with field experts to find just the right location, and corporate marketeers to get the message out, and distribution channels to get product on time, and training systems to increase your competency.

But, the number one item on the franchise failure list is...

Under-capitalization.

In other words, you, the franchisee are losing money because you were too 1) optimistic about this "proven system", 2) could not weather "unexpected" situations within this "proven system", 3) you did not plan correctly, that is, within this "proven system" you should have planned on negative cash flow for a "couple of years".

The under-capitalization mantra is a convenient method to string franchisees along while the rest of the "franchise chain" gorges at the trough.

This should be a RED FLAG to any 'zee wannabee ...

Under-capitalization

Read between the lines:

A franchise is a "proven system" with field experts to find just the right location, and corporate marketeers to get the message out, and distribution channels to get product on time, and training systems to increase your competency.

But, the number one item on the franchise failure list is...

Under-capitalization.

In other words, you, the franchisee are losing money because you were too 1) optimistic about this "proven system", 2) could not weather "unexpected" situations within this "proven system", 3) you did not plan correctly, that is, within this "proven system" you should have planned on negative cash flow for a "couple of years".

The under-capitalization mantra is a convenient method to string franchisees along while the rest of the "franchise chain" gorges at the trough.

This should be a RED FLAG to any 'zee wannabee ...

Franchise Failure

Those are all proper areas of comment and highly relevant. On the other hand, it's time that political correctness was left in the ditch and the role of misrepresentation in the franchise sale process received serious examination. Deal due diligence gets short shrift in favor of "reading the contract". It's the deal due diligence that roots out the fraud and saves the investor from ruin, not "reading the contract".

Under-capitalization and Churning --Zees Beware

Sure! when franchisors sell their franchises and give you an estimate on what it will take to break even, you expect that there will be a few years to break even and you arrange your life and finances and borrow money based on their good faith estimates.
Franchisors, of course, under the law and the terms of the franchise agreement, are not responsible for their estimates whether they are made in good faith or bad faith.
When you still have a nagative cash flow after two to three years, do you dig the hole deeper, as so many do, or have you exhausted your sources of capital and credit and do you fail and lose your enntire investment to a second-gemneration franchisee who has a better chance, maybe, of breaking even, because of their low investment costs and the extra time to build gross sales that may bring the business to break even.
In large networks that churn and turn, all the risk is bourne by the first and succeeding franchisees and as long as the franchisors can keep selling franchises and hiding the fact that "transfers" are failures in the UFOC's, can't they just churn forever and garner profits?
Do the lawsuits against Churners like UPS and Quiznos work in any way to stop the churning and slow down the sale of these franchises to the public?

The determination of adequate working capital is part of

competent deal due diligence.

Item 7 in every FDD I have ever seen understated working capital requirements. The assumptions in every business plan I have ever seen for a franchise start up has continued that understatement. No one works out the more probable requirements based upon reasonable estimates of how long it takes to hit break even - and that's on a good franchise deal. Ignorant people think of hitting break even in a year or less. That is astoundingly inadequate, even though some do achieve that target.

If you don't properly estinmate working capital required, leaving yourself a good cushion for big error, and include in that what you need to live on in addition to the working capital required, your unit will be available for resale rather soon.

Working capital inadequacy works to produce many churning opportunities. Even when  that is not the problem, and the unit comes up for resale for other reasons, people do not know how to look for "pump and dump" while the resale unit is being operated by the franchisor prior to its resale. They also don't know how to look for booking sales from other locations into the resale unit to make it look better than it really is.

Trying to put all the emphasis on something called "churning" neglects the other practices that enable churning to be as serious a problem as it is. Only deal due diligence can help a buyer avoid being victimized in that scenario.

The deeper hole

Not that long ago I added some serious money to the bottom line for a franchisee by identifying what one issue was putting him under pressure in almost every aspect of his business and importantly why he insisted on making my life miserable.  Once he got used to the fact that there was consistency in what had been put in place everything in his business improved.   And I get 10 less needy phones calls a week.

The point is that when a franchisee enters into a franchise contract and is under-capitalized everything will suffer … when an operator focuses entirely on dollar performance and forgets about the clients then he is on his way out.  And that is what happens from pressure and fear.

Prospective franchisees tend to ask the question; ‘what will it cost me to get in?’ instead of ‘what will it cost to survive to breakeven?’  But wait; ‘it’s a franchise brand and customers will rush the opening.’ Just sign here ……. s ... t ... u ... p ... i ... d

Framchisor's Estimated Startup an Implied Earnings Claim

 The estimated startup costs provided by the franchisors act as an implied earnings claim,  don't they?   

 The franchisor is not responsible for the accuracy of estimated startup costs and has the incentive to keep them as low as possible in order to sell the franchise.     Yet,  franchisees borrow and make plans based on the "good faith?" estimate of the franchisors.   

Again,  the franchisor doesn't have to back up the estimates with any kind of pro-forma statistics and the FDD continues to do its work as a red herring to obscure the risk of the purchase of the franchise.from the new buyer.    

 

Re: Franchisor's Estimated Startup an Implied Earnings Claim

Carol Cross Eblen the answer is no.

J.

 

Actually, all of Item 7 is an earnings claim in fact, even if it

isn't in law. Practically no franchise investor understands that it is a three month picture, no matter what it says. When they prepare their "business plan" they use Item 7 information for far more than three months planning, especially when it comes to what is laughingly called Working Capital in Item 7.

This is an example of knowing the difference between the law and the realities. The law is the product of a legislative/regulatory deal. Reality is reality.

Michael's answer is technically correct, but incomplete in this respect.

Re: Actually, all of Item 7 is an earnings claim in fact, even i

A compliant FDD Item 7 is a product of franchise regulation. It is imperfect. However working capital needs in business plan have to consider debt service coverage among other factors and certainly a reasonable person will take this aspect into account.

J.

Incomplete

Richard writes: "Michael's answer is technically correct, but incomplete in this respect."

I agree, but it is much worse than that.

Any information found outside the FDD cannot be legally relied upon  - thus really putting the onus on the franchisee to do excellent due diligence.

re: Incomplete

You're entirely correct.

Like anything good that comes out of the oven, the real flavor of the mix is under the crust, and in the case of franchising, the crust is an FDD/FA.

There is still only one way to understand the true nature of an offering, and that understanding is found on the street, not on a desk. If a concept has no credibliity where it counts, it has no credibility with or without 'fair contracts'. Of course, most of us with old scars are now drinking from the same bottle.

re: Incomplete

You're entirely correct.

Like anything good that comes out of the oven, the real flavor of the mix is under the crust, and in the case of franchising, the crust is an FDD/FA.

There is still only one way to understand the true nature of an offering, and that understanding is found on the street, not on a desk. If a concept has no credibliity where it counts, it has no credibility with or without 'fair contracts'. Of course, most of us with old scars are now drinking from the same bottle.

FDD Item 7

Carol asks: "The estimated startup costs provided by the franchisors act as an implied earnings claim,  don't they?   "

No, that is why by convention the franchisors only provide data for 3 months of carrying costs - to do otherwise would be an implied earnings claim.

In Ontario, this may be different.

Implied Earnings Claim

Yes!  But the average naive franchise prospect doesn't understand that the estimated startup costs advertised in the presale process and considered by the courts to be just part of "puffery" and "marketing"  are generally inaccurate and are not to be relied upon.    Unfortunately,  they haven't read Richard Solomon's tutorials and advice.             

The unrealistic data,  FDD Item 7,  3-months of carrying costs,  is not understood by the investing franchisee,  who,  of course, is relying on the "implied earnings claim"  made outside of the FDD,  that supposedly is against the law in the United States.   Prospective franchisee buyers get NO  protection from the FTC under false advertising laws because of the blank check given to the franchisors by way of regulation and the standard adhesory franchise agreement.      

Why should franchisors be allowed to make implied earnings claims outside of the FDD and then cover themselves completely for the inaccuracy olf these estimates within the contract wrapped in the  Franchise Disclosure Document?      Just more of t he same!   Franchisees,  under law, process, and procedure are rendered to be merely ex[emdable resources for franchisors to expand their chain operations in the economy.       

Re: Implied Earnings Claim

The 3 months estimate follows the FTC Rule.

Carol Cross Eblen - Why do you pusue  foolish general polemics when you could go after specific abuses by individual franchisors that are blantantly violating laws? I think the reason is that you so want to damn every franchisor, well that is stupid and is why you have the credibility you enjoy. 

J.

 

 

Implied Earnings Claim is another systemic abuse

It is my goal to try to expose the fatal flaw of the FTC Regulation that enables franchisors to sell unprofitable franchises to the public,  with apparent immunity under law,  as long as they are somewhat compliant with the regtulatory rule.   The Inducement Problem in franchising has been covered by experts like Richard Solomon,  Franchise Remedies,  who indicates that regulation doesn't protect franchisees and that only due diligence with attorneys who know the "score"  can save prospective franchisees from the franchise from hell.    

All franchisors enjoy the advantages of ineffective regulation!    Apparently,  Javier Hurlbert,  you engage in personal insults because the truth may impact on your ability to make a living in and around franchising.   I understand.    

 

RE: Implied Earnings Claim is another systemic abuse

Firstly, I made no personal attack and I am offended by your accusation.

Secondly, I pointed out your polemics are ineffective, self-serving and they diminish any veracity a person might find in your comments.

J.

The law and the realities are such that frachisors have paid for

the right to make the claims they make - that are compliant with the rules. It is then up to the investors to sort out the realities in due diligence. Reading the tutorials on my web site does not make you competent to perform pre investment due diligence. They heighten your sensitivities to the fact that there are risks you can't sort out - and that is all they do in reality.

Then there are the new franchisors who don't come anywhere near staying within the lines, because they aren't in it for the long haul anyway. If they are still in business five years down the road, no one is more surprised than they are. They are in it for the quick score. You have to know how to sort that situation out, and my tutorials don't give you that competence either.

No tutorials, regardless of by whom written, can fill in for not having many years experience analyzing franchise systems qualitatively. You might as well read Chuck Yeager's autobiography and then try to fly an airplane.

Franchisee Match or Mismatch?

All of these comments are all right on. 

Dick is a great writer and I have had the pleasure of working with him in the past.  I would like to address Dick's #4 - Poor Fit between Zee & Zor. About a year and a half ago Dick wrote an article about my Franchise Navigator and how franchisors and franchisees, alike, can determine if a franchise is a good fit for each other.   In the past there was no way for a franchisor to understand what this meant and how to determine if someone is a good fit until after the fact, when problems in the relationship occur. 

Further, franchise sales people are trained (maybe) to sell franchises but not how to interview and assess an individual's skills, values and behavior and fit with the franchise.  You could take 5 franchise salespeople, all from the same company, and ask them to describe the right candidate and you will get 5 different answers (we have done this many, many times).  The franchise sales people don't want to go back for additional training because it means they must make an investment of time and energy to develop new competencies and skills.  So, in reality, a franchisor is represented by a sales person who sells the franchises and the franchisor then has to live with and support this person who has bought into the franchise for what they thought were all of the right reasons.

Through our research during the past 29 years with hundreds of franchisors, I can show you numerous companies who have sold a lot of franchises ...... to the wrong people.  When I refer to "wrong people" I am referring to good people who lack the skills, values and behavior to execute the company's business and franchise model.  We often see franchisors advising prospective franchise owners to assess themselves but, honestly, they don't know how to do that either.

Having been in franchising for a very long time I have seen a lot of the good and not so good stuff.  I can also tell you, that in my opinion, most franchisors are "packaged" to sell franchises and are never educated on how to perform as a franchisor nor what their franchisee profile should be.  Many of these "packaged" franchise companies do not understand the depth of what is actually required to be a successful franchisor as they generally are very entreprenurial and not professional businesspeople and they will sell their franchises to anyone who shows an interest.  There are, of course, mature franchisors who also don't "get it" either.

I believe the future of franchise system xpansion will be to create a high performer profile that identifies the people best suited to operate the business, and then recruit people who resemble this high performer profile.  If the franchisors would do this I believe there would be less "selling" of franchises and more coaching on whether the franchise prospect is a good fit for the franchise.  This is all about the Human Capital part of growing a business that up until recently was absolutely ignored in franchising.

If anyone has any questions please visit www.franchisenavigator.com.  On the left side is the Franchise Navigator, for franchisors and the right side is Connect Me, which will match prospects to the high performer profiles we have created for almost 100 franchisors. 

Craig Slavin

Franchise Central - www.franchisecentral.com

Franchise Navigator - www.franchisenavigator.com

Franchisee Match or Mismatch?

All of these comments are all right on. 

Dick is a great writer and I have had the pleasure of working with him in the past.  I would like to address Dick's #4 - Poor Fit between Zee & Zor. About a year and a half ago Dick wrote an article about my Franchise Navigator and how franchisors and franchisees, alike, can determine if a franchise is a good fit for each other.   In the past there was no way for a franchisor to understand what this meant and how to determine if someone is a good fit until after the fact, when problems in the relationship occur. 

Further, franchise sales people are trained (maybe) to sell franchises but not how to interview and assess an individual's skills, values and behavior and fit with the franchise.  You could take 5 franchise salespeople, all from the same company, and ask them to describe the right candidate and you will get 5 different answers (we have done this many, many times).  The franchise sales people don't want to go back for additional training because it means they must make an investment of time and energy to develop new competencies and skills.  So, in reality, a franchisor is represented by a sales person who sells the franchises and the franchisor then has to live with and support this person who has bought into the franchise for what they thought were all of the right reasons.

Through our research during the past 29 years with hundreds of franchisors, I can show you numerous companies who have sold a lot of franchises ...... to the wrong people.  When I refer to "wrong people" I am referring to good people who lack the skills, values and behavior to execute the company's business and franchise model.  We often see franchisors advising prospective franchise owners to assess themselves but, honestly, they don't know how to do that either.

Having been in franchising for a very long time I have seen a lot of the good and not so good stuff.  I can also tell you, that in my opinion, most franchisors are "packaged" to sell franchises and are never educated on how to perform as a franchisor nor what their franchisee profile should be.  Many of these "packaged" franchise companies do not understand the depth of what is actually required to be a successful franchisor as they generally are very entreprenurial and not professional businesspeople and they will sell their franchises to anyone who shows an interest.  There are, of course, mature franchisors who also don't "get it" either.

I believe the future of franchise system xpansion will be to create a high performer profile that identifies the people best suited to operate the business, and then recruit people who resemble this high performer profile.  If the franchisors would do this I believe there would be less "selling" of franchises and more coaching on whether the franchise prospect is a good fit for the franchise.  This is all about the Human Capital part of growing a business that up until recently was absolutely ignored in franchising.

If anyone has any questions please visit www.franchisenavigator.com.  On the left side is the Franchise Navigator, for franchisors and the right side is Connect Me, which will match prospects to the high performer profiles we have created for almost 100 franchisors. 

Craig Slavin

Franchise Central - www.franchisecentral.com

Franchise Navigator - www.franchisenavigator.com

Franchise fits is important - but how would a 'zor

first establish their 'ideal' franchisee profile without having burned a few in the early stages of their system?

Or do you advocate that a propsective 'zor runs a pilot store (or two)?

Franchisee fit is a critical success factor; I have sen 'zees perform miserably in one system, only to pop up in a competitors system (in the same industry) and perform well. 

The culture is a huge influence upon success - and a 'zor that is just interested in selling more units has a culture that immediately raises red flags.  By the same token, identifying whether a 'zee is likely to fit that culture is an issue that is often overlooked or ignored on both sides of the fence.

On a different track, there are not as many 'proven' franchise systems as people assume - and like the salespeople Craig mentions, the definition of 'proven' can mean different things to different people (and most of all to the 'zor).  As a consequence I would put "franchisees lack of relevant experience" high on the list of the causes of failure.  A potential 'zee with experience in the industry is going to be much more aware of the reality of the claims being made by the ' zor.

Or do you advocate that a propsective 'zor runs a pilot store (o

Simon,

Here is a fact that many people fail to understand about franchising.

A company that franchises actually operates their business in two distinct marketplaces.  The first, and the most important, is at the consumer level where they provide a product or service to the end user for either usage or consumption and; the Franchise Level, where the goal is to open more locations to provide more products or services to the end user for usage or consumption. 

You cannot operate in the franchise marketplace unless the business has validated at the consumer level.   At the consumer level, if the business has validated, the company can establish rules for operating the business based on what works and what doesn't.  This includes establishing the right profile of operator/owner/franchisee.

Unfortunately, I can show you many companies who franchise without validating at the consumer level because they don't have pilot stores or prototypes.  I don't know what they call it but I don't call that franchising.

Or do you advocate that a propsective 'zor runs a pilot store (o

Simon,

Here is a fact that many people fail to understand about franchising.

A company that franchises actually operates their business in two distinct marketplaces.  The first, and the most important, is at the consumer level where they provide a product or service to the end user for either usage or consumption and; the Franchise Level, where the goal is to open more locations to provide more products or services to the end user for usage or consumption. 

You cannot operate in the franchise marketplace unless the business has validated at the consumer level.   At the consumer level, if the business has validated, the company can establish rules for operating the business based on what works and what doesn't.  This includes establishing the right profile of operator/owner/franchisee.

Unfortunately, I can show you many companies who franchise without validating at the consumer level because they don't have pilot stores or prototypes.  I don't know what they call it but I don't call that franchising.

Franchisor's Validation

Craig writes: "Unfortunately, I can show you many companies who franchise without validating at the consumer level because they don't have pilot stores or prototypes.  I don't know what they call it but I don't call that franchising."

While I agree with this, this is a necessary but not sufficient condition.  Many would be franchisors develope a system from a well run store, but their development is so geographically diverse as to lose any network effects. I believe that the Taco Del Mar system suffered from this problem: some good stores in the Seattle area, and then far flung stores outside the natural distribution route.

Please clue me in on why

Please clue me in on why anything Dale Nabors ever submitted on this site is still posted and why anyone would respond to it?