How do Recessions affect Franchising?

By Michael Seid, Managing Director, MSA Worldwide

How do economic downturns generally impact franchising?

Franchising is generally countercyclical to the economy; during the last economic downturn, the growth in franchise systems was quite strong. Why?

• As job losses increase and people feel their security is threatened, people turn to entrepreneurial thoughts.
• The perception of franchising as a “safe” investment makes it an attractive option during a recession.

The same scenario plays out when ROI in more passive investments becomes challenged. Smart franchisors understand the opportunities in a down economy and will take advantage of them.

Impacts of recession on franchise system sales

All these are expected impacts on franchise systems during an economic downturn:

• Even though there will be a flow of new people looking to become franchisees, franchise sales will be impacted.
• Franchisors and franchisees will need to deal with both a tightening of credit requirements by lenders, and a lessening of housing equity available as collateral for loans.
• The existing pipeline of franchise development from current franchisees will also be impacted somewhat.
• Franchisors will need to modify their marketing approach and message, and recognize that their requirements for prospective franchisees during this period will change.
• Until the economic news stabilizes a bit and franchisors get through the normal short-term fear by potential franchisees of commitment during unsettling times, franchise sales will take longer to close.

But, this article is not about selling franchises in a down market. Why not? Franchise sales and expansion are not where your primary focus should be during a recession. Unit performance and sustainability are what you need to keep your eyes on.

Focus on franchise unit performance and sustainability

Ask any experienced and smart franchise executive – “How’s business?” – and they will discuss same-store sales, average unit volumes, customer counts, cost of goods, labor rates, etc. Experienced franchisors focus on what is required to sustain the franchise system in good times and bad, and unit performance is at the center of their universe.

Ask inexperienced franchisors the same question, and most will focus on franchise sales and how well their franchise development pipeline is doing. Now, you might be able to focus primarily on franchise system growth in good times, but when the economy takes a dip, taking your eyes off of unit bottom-line performance can be catastrophic. Franchising is resilient, but it is not immune to the economic bubble.

How are your franchisees doing?

Recently I moderated a panel on managing the brand at a franchising conference. My panel was diverse, but all were experienced in franchising. I had management from a mature franchise system, a multi-unit franchisee, a franchisee lawyer, and a franchisor lawyer. Our discussion on managing the brand centered on unit performance, cost of goods, return on investment, long term strategic planning, and the inclusion of franchisees in the management of the brand.

As I often do, I asked the franchisors in the audience a few questions, including:

• How many of you know what your franchisees are making?
• How many of you routinely check your franchisees’ return on investment?
• How many of you verify the initial investment you include in your disclosure document, including the necessary working capital?

The folks from larger franchise systems raised their hands… but most franchisors in the audience did not. During a recession, franchise failure is most likely in franchise systems where franchisors aren’t monitoring unit performance, and instead are primarily focused on franchise system expansion.

What to do when unit performance is lagging

So what should you be looking for during down times, that’s different than what you should be looking at in good times? Experienced franchisors will answer – Nothing really. Great franchisors are always looking at unit performance. But when unit performance is challenged, you should put additional effort into these areas:

• Tighten up your communication and cooperation with your franchisees. Make certain you know what’s happening at the retail level. Listen to their needs, but understand that you are still managing the brand.
• Make the necessary adjustments to your marketing messages and strategy, and consider changes to your retail offering as necessary. Look for ways to shorten your new product route to market.
• Review your standard retail and promotional price position.
• Challenge your suppliers for efficiencies and savings.
• Make certain your field staff focuses on your franchisees’ top and bottom line. Small adjustments in labor, shrinkage, local marketing, etc., can have a major impact on both unit performance – as well as your relationship with your franchisees.

Cash is not only king in a down economy – it’s vital

Review, with your franchisees, their financial condition. Ensure they are able to meet their obligations, including debt service and payroll taxes. Make certain they are not stealing from the advertising budget instead of looking for savings elsewhere. Cutting advertising will most definitely have an impact on their top line sales. Franchisees need to have a clear understanding of their future, and talking to them about taking less out of the operation may be a difficult but necessary conversation.

Sometimes franchisees may ask you for royalty reductions, or forgiveness of debts or even loans. But you’re not a bank. You’re a franchisor. Providing this type of assistance generally is not a good idea, but there are times you may need or want to consider doing so. Understand the issues and ramifications, and work with experienced professionals before you start down this path.

Remember, in a down economy, customer counts and unit sales will likely be the first thing to suffer. Your royalty income will get smaller, and your royalty receivables will likely become larger. Keep an eye on your own finances, operational, and organizational costs. You need to operate smarter in these times. But, don’t forget that now is the time to also look for the opportunities this type of market always provides to those that are looking for them.