When times get bad

when franchise fails

By Michael Seid, Managing Director, MSA Worldwide

Q. I understand that historically during slower economic times, people purchase franchises. Is this true, and why would someone want to start a franchise when the economy is slow?

A. An interesting phenomenon of a general downturn in the economy has often been the growth in franchise systems that occurs while the rest of the economy is going south. Driven by the fear of losing their jobs or the uncertainty of what the economy will do to their company and therefore their chances for advancement, people begin to seek ways to get control over their destiny.

Out of work and facing industries no longer clamoring for their special talents – people look for opportunities elsewhere. Ownership of a business has always been a popular path to achieving the “Great American Dream” of financial success. For many individuals, more importantly, franchising may be their ticket to personal independence and the end of the fear of ever being laid off again.

Whether it is true for every franchise opportunity, franchising usually comes with the benefit of proven systems and brand names, and therefore there is a perception that it can reduce the risks associated with starting a new business. Individuals purchasing franchises have been a staple of franchising’s growth since the end of WWII.

Two other franchisee constituents have emerged and strengthened since the last sustained downturn of the eighties and early nineties – multi-unit operators and investor groups.
Multi-unit ownership has been the major growth vehicle for many franchise systems during the past ten or fifteen years.

Based upon their satisfaction with the performance of their franchise investments, individuals have simply purchased more and more locations. Most times they purchased franchises from the same franchisor to leverage their knowledge of the business and the strength of the franchisor’s brand in their markets. But, frequently today, many multi-unit franchisees are buying franchises from several franchisors. The reason for doing so may be that there are no longer any additional locations in their markets that meet their requirements. While they want to continue to expand, they don’t necessarily want to expand into other markets, or they may simply want a new challenge or opportunity.

Multi-unit franchisees have also developed a business infrastructure for the management and operation of their locations. This often includes typical office personnel for payroll and administrative functions, but can also extend to training personnel, site selection and development capabilities, field personnel for management, etc. That infrastructure which was developed to manage and grow their existing investment now can be used to enable them to develop multiple brands. It allows them to spread their investment risk, maximize their overall investment, and leverage their knowledge of their existing markets.

In addition to franchisees that have grown their businesses one location at a time, investors have also begun to understand franchising during the past few decades. When passive investments in the stock markets are strong and return on investment is secure and strong, money flows into the capital markets – stock ownership. However, as the market becomes soft, as companies begin to lay off staff and entrench, as the papers fill with news of the demise of Enron, K Mart, Service Merchandise, and seemingly every dot com with the possible exception of, investors turn to the stability and higher returns possible from franchised locations.

Those investor groups, instead of purchasing one location at a time, purchase entire markets and agree to develop a minimum number of locations over an agreed period of time. They leverage the weakening labor market that exists during the downturn, and take advantage of lower rents as the real estate markets soften.

Is it a good idea to turn to franchising as the economy softens? Yes and no. There are some spectacular opportunities in franchising today. The return on investment that some franchisees are able to earn was strong before the downturn, has continued, and in some industries even improved. Look to those industries that are not only recession-resistant but that can take advantage of the trends and opportunities created by the changing economy. These may not be available in every industry segment that is franchised, but you can find opportunities that fit every investor’s pocketbook.

But, simply buying a franchise is not a guarantee of success. It’s a mixed market. For example, franchisees of some of the larger, more established franchise systems are seeing the value of their investments wither as their businesses have become less and less profitable, while franchisees of other systems in the same industry are doing just fine. Some concepts and management are better able to weather difficult times than others. Often, the difference in a down economy is that consumers set great store in companies that can deliver quality and value and are able to meet their continuing need, more than companies that historically drive sales one promotion at a time.

At the same time, the development of new franchise systems and opportunities is booming. Brand name companies that may never have franchised before are offering some of the opportunities. Some are being offered by brand new start-up franchisors that were not even in business a year ago. These new concepts often can take advantage of trends better than more established companies that have to retool an entire system to make the change.

In a soft economy, spending the time necessary to investigate not only the franchise opportunities but also investigating where the opportunities are is very important. Look at companies that have benefited from the softening market, and see if you can determine why they are so strong. Even if they are not offering franchises, you may be able to locate some of their competitors that do. The Internet is a wonderful source of information. Use it and don’t rush.

Don’t get caught up in the hype of buying a franchise. Franchise salespeople are the kings of spin, and brochures and websites always paint a rosy picture. They will always talk about the strength of their concept, the fact that it is recession-proof, and why it will only get stronger. Often they are telling you the truth.

Franchise brokers – those companies and individuals that sell franchises for several concepts – will talk about the strength of their client’s concepts – that is their job also. However, you need to remember that while they may not call themselves “brokers” and may represent themselves as “consultant and advisors,” they represent the franchisor and not you. Don’t be surprised that the psychological test they often give you determines that the perfect franchise for you just happens to be one of their clients. Many companies are using brokers today to sell their franchises. Competition for new franchisees is tight, and some franchisors think they need brokers to keep their development pipeline full. Some franchisors are also more interested in selling franchises than selecting the best franchisees. Be careful that the franchise you invest in provides you with the best return on your investment and is not simply the one the franchise broker got the bigger commission check from. It’s your responsibility to do your homework.

Do you have further questions about navigating change in franchising?

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