Downturn in the Economy?

when franchise fails

By Michael Seid, Managing Director, MSA Worldwide

How do economic downturns generally impact franchising?

During the last downturn, the growth in franchise systems was quite strong; franchising is generally countercyclical to the economy. As job losses increase and people feel their security is threatened, they turn to entrepreneurial thoughts. Often, the perception of franchising as being “safe” makes it an attractive option. The same scenario plays out as the ROI in more passive investments becomes challenged. Smart franchisors understand the opportunities in a down economy and will take advantage of them.

Even though there will be a flow of new people looking to become franchisees, franchise sales will be impacted during this period. Franchisors and franchisees will need to deal with both a tightening of credit requirements by lenders, and also a lessening of housing equity available as collateral for loans. The existing pipeline of franchise development from current franchisees will also be impacted somewhat. It will be important for franchisors 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 we get through the normal short-term fear by potential franchisees of commitment during unsettling times, franchise sales will also take longer to close. That is to be expected.

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

Ask any experienced and smart franchise executive – “How’s business?” – and 99 out of a hundred times your discussion will be around same-store sales, average unit volumes, customer counts, cost of goods, labor rates, etc. Experienced franchisors are focused on what is required to sustain the system in good times and bad, and unit performance is at the center of their universe.

Ask others the same question, and lately it seems that most franchisors are focused on franchise sales and how well their franchise development pipeline is doing. 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.

Recently I was moderating 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 am often prone to 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 the larger franchise systems raised their hands, but most of the franchisors in the audience did not. If there is going to be a bubble breaking in franchising, it is likely going to be in those systems where franchisors are not monitoring unit performance and instead are still primarily focused on franchise system expansion.

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

  • Tightening up your communication and your cooperation with your franchisees. Make certain you know what is happening at the retail level. Listen to their needs, but understand 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 is focused on the 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 that 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 you may be asked for royalty reductions or forgiveness of debts or even loans. 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 who have been through this 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.

Do you have further questions about navigating change in franchising?

MSA can provide expert guidance on how to build a successful and adaptable franchise system for the long term.

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