Multi-Unit Franchisee Magazine Issue II, 2015 | Page 98
FranchiseMarketUpdate
BY DARRELL JOHNSON
Failed Units: Not Just
a Franchisee Issue
Aligning interests benefits the whole system
T
hroughout my career I have observed that a strong alignment of
interests between two business
parties usually leads to good outcomes for both. All franchisors with any
marketing savvy will say they are strongly
aligned with their franchisees. What is the
evidence that a brand walks the talk?
There are many ways a franchisor can
help its franchisees, starting with a full and
high-quality support program, and including a disciplined prospect screening program, training that measures results, site
selection and opening assistance based on
proven criteria, and field operations and
compliance that are effective.
Then there’s transparency. Brands that
have a meaningful Item 19, that have system
dashboards that compare unit performance
in real time, that support capital access
through SBA eligibility and Bank Credit
Reports (BCRs), and that seek system feedback through independent third parties are
further examples. Brands that “get it” tend
to not only focus on these types of operational performance measures, but actively
compare how they are doing against peers.
At FRANdata, we benchmark best practices
in these areas all the time.
In an absolute sense, all these indicators
are aimed at a pretty simple concept: unit
success or failure. Over the long term, the
only reason a unit will stay in business is
because it is profitable. While we tend to
acknowledge the financial impact on franchisors of a failed unit, we rightfully focus
mostly on the impact on the franchisee.
After all, for most single-unit franchisees
the cost of a failed unit is absolute and often
devastating. It can represent the loss of a
business, the loss of most of a franchisee’s
personal net worth, the loss of their main
source of income and job, the likely loss
of other jobs, and the resulting impact on
many families. For multi-unit franchisees,
the cost of a failed unit usually isn’t quite
as devastating personally or financially,
but it is real and negatively affects people.
The obvious impact on the franchisor is
96
a loss of royalty revenue. A franchisor has
made an “investment” in finding, training,
and supporting a franchisee as well as assisting in siting and opening a new unit. In
our comparative research on operations for
brands, we have found that the sunk cost
incurred by a franchisor varies widely and
can be a significant multiple of the net fees
obtained up front. Those up-front costs
put unit breakeven for many franchisors
“The rise in the
loan failure bell
curve starts after
two years, about
the time most
franchisors have
recovered their
fixed costs and
are beginning
to realize a net
return.”
more than two years out when compared
with the unit royalty ramp-up.
We also have found that most new
franchise units hit breakeven in a 12- to
24-month time frame, based on our BCR
data. From many years of providing brand
credit analysis for lenders, we also have
tracked the time from funding to loan failure
(loan failure and unit failure are correlated,
but not as highly as is generally thought).
The significant rise in the loan failure bell
curve starts after two years, about the time
most franchisors have recovered their fixed
costs in a unit and are beginning to realize a net return. Put all this together and
it certainly creates an alignment of interest between franchisors and franchisees.
However, this is a very limited and
short-term assessment of the cost of a failed
unit to the franchisor. An under-qualified
franchisee prospect requires more support.
A weak site selection program lengthens
the time to unit breakeven. An underperforming unit takes more field support
time. A struggling unit requires the time
and attention of franchisor staff, and often
management time. An underperforming
franchisee almost always has an impact on
other franchisees, often leading to system
culture issues. A failed unit creates consumer
brand perception issues, and a failed franchisee often creates negative social media
and even traditional media issues.
Whether or not a franchisee fails, a
closed unit is a big negative to the lending
community. Just a few closures can result in
lenders staying away from those brands. At
the very least, it affects the terms lenders
are willing to offer. Through our analysis
of performance we have found that, when
measured over enough time, a historical unit
success rate serves as a good medium-term
predictor of future performance outcomes.
We are currently incorporating this metric
in credit rating products for lenders and it
is being well received.
This brings us back to the alignment
of interests. Wouldn’t brands that grasp
a fuller concept of unit/success implications at all three levels—franchisor, system, and franchisee—be the brands that
will have the most success? An important
question that both prospective franchisees
and multi-unit franchisees should ask is,
Which brands exhibit the best understanding of this concept? Our research projects
with franchisors are leading us to develop
performance standards that measure the
full cost of a failed unit and analysis of
the causes. With such an understanding,
franchisors should more efficiently allocate
their human as well as financial resources.
The result for franchising will be fewer
failures, a stronger business model, and
above-average brands with some serious
marketing bragging rights.
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 [email protected].
MULTI-UNIT FRANCHISEE IS S UE II, 2015
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