What lessons can we learn in advance ?
FranchiseMarketUpdate
BY DARRELL JOHNSON
The Coming Recession
What lessons can we learn in advance ?
One of the economic truths for the U . S . economy is that we have recessions , and the next one is coming . Maybe not in the next month or even the next year , but it is coming . We have had 11 recessions since WWII and are currently in the second longest-running recovery of those 11 recessions . Time is not on our side .
One of the economic realities from recessions is that we usually end up with permanent changes to our businesses . Often those changes are related to what caused the recession . The last recession was caused by a subprime mortgage crisis that led to a global financial crisis . Financial institutions were permanently affected , with changed capital requirements and a lot more regulatory scrutiny . The result was that lenders changed how they went about assessing risk , including franchise lending risk . A common joke during the run-up to the 2008 recession was that if a prospective franchisee could fog a mirror , they could get financed .
Back then , the general view within lending circles was that franchise financing was low-risk financing , because most lending portfolios in the mid-2000s didn ’ t have much franchise loan stress showing . Lenders made two false assumptions , however . First , when it comes to risk , not all franchise systems are equal . Second , it takes three to five years for the majority of new units to reach full stability . Brands with significant unit growth spurts had not reached system stability in the years just before the downturn . The result of being wrong was a predictable knee-jerk reaction by lenders and a dearth of capital available for franchises in the years following the end of the recession in 2009 .
Gradually , lenders addressed the two errors they ’ d made . They started differentiating franchise brand risk beyond simple but ineffective screening criteria such as : at least 30 franchise units , 5 years of franchising , and SBA loan loss data . ( The first two of these didn ’ t define risk at all , and the last was recognized as be- ing based on substantially flawed data .) Lenders gradually tossed these criteria and learned to assess franchise brand as well as borrower credit risk in better ways , which opened the lending gates to brands judged to have lower risk . FRANdata helped this transition with franchise brand FUND ratings and more creditbased risk information available to lenders on the Franchise Registry .
Multi-unit operators should have a significant voice , and that voice should be collective and loud .
Lessons for today With the lessons learned from the last recession , what are the likely lessons we will learn from the next one ? To answer that , let ’ s turn to what likely will cause the next recession . With no looming economic bubbles , it is more likely that the next recession will be driven by consumer confidence dropping . We don ’ t have any industries overheating today , and we aren ’ t in an a state of “ irrational exuberance .” In fact , this economic recovery is notable for its lack of specific economic drivers other than the Federal Reserve ’ s monetary policy . The Fed ’ s actions did keep the economy growing , but the recovery has been so slow that it seemed like no recovery at all .
This economic recovery is also notable for its lack of productivity growth . Productivity improvement usually comes from capital investment , the absence of which stands out today . There are many reasons , but it ’ s the impact that is important . We drove labor toward full employment , and labor issues became the focus of many state and federal actions . This caught the franchise business model at a bad point in its evolution as the franchisor-franchisee pendulum had swung significantly toward the franchisor . In the interest of protecting the brand — and , in many cases , genuinely seeking to help franchisees become more successful by providing more guidance into their operations — franchisors became vulnerable to attacks on the business model itself . The result was a plethora of state and federal legislative initiatives , as well as regulatory actions , that had direct implications on the franchise business model .
Some in the franchising community may take solace in the probability that the recent election will take pressure off labor-specific issues . However , they will be missing the lessons that the last few years of business model attacks have presented to the franchise community : from the language we use in franchise agreements and operations manuals , to a reassessment of the range of services that franchisors should be responsible for relative to franchisees .
Essentially , the legislative and regulatory challenges we ’ ve had to confront in recent years should push us to understand why they occurred , and provide the opportunity to reassess each of the franchisor functional areas that have evolved into what is common practice today . On that point , multi-unit operators should have a significant voice , and that voice should be collective and loud .
In recent years , much of FRANdata ’ s research for franchisors has been around what “ best ” looks like , and which brands come closest to meeting “ best .” This requires defining a standard and measuring brands relative to that standard . Following the last recession , we learned how to do that around franchise credit risk . I hope we now can do the same with the aggressive legislative and regulatory problems of recent years . We certainly need to prepare for the next recession . And what better way than to fine-tune operational best practices ?
Darrell Johnson is CEO of FRANdata , an independent research company supplying information and analysis for the franchising sector since 1989 . He can be reached at 703-740- 4700 or djohnson @ fran data . com .
80 MULTI-UNIT FRANCHISEE ISSUE I , 2017