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Economic downturn

Time to focus on bird already in hand


Michael Seid

Our columnist, who still misses Ronald Reagan, has some ideas on how franchisors can  help improve unit economics in tough times.

You don't need to spend much time reading The Wall Street Journal to understand that our economy is going through a bit of a rough patch.

The five wise men over at the Federal Reserve are cutting interest rates. Hillary and Barak want to take money from your pocket and give it to someone else; Pelosi and Reid are blaming the housing and credit crisis on Bush; and everybody is blaming ExxonMobil for $4-a-gallon gasoline. The good news is that we have a do-nothing Congress and the private sector will sort it out during 2009 so long as McCain wins the election in November. (Editor: Please note this is purely Mr. Seid's opinion, not to be confused with that of the editorial staff.)

So, for the next year or so, how will the economic downturn impact franchising and what can you do about it? 

During the last downturn, the growth in franchise systems was quite strong. Remember 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 return on investment in more passive investments becomes challenged. Some economists predict there is no reason to expect this down turn to be very long or very deep. Some even think the economic challenges may be amplified by the media as part of this year's election cycle. 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 the credit requirements by lenders and also a lessening of home equity available as collateral for loans. The existing pipeline of franchise development from current franchisees will also be impacted somewhat. Real estate will begin to open up a bit as existing businesses close and landlords will likely open their wallets a bit wider with construction allowances, etc.

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.

Eyeing unit performance

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 eye on.

Ask any experienced and smart franchise executive, "How's business?" and 99 out of 100 times your discussion will be centered 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 both good and bad times, and unit performance is at the center of their universe.

Lately, however, it seems many franchisors are focused on franchise sales and how well their franchise development pipeline is doing. You may be able to focus primarily on franchise system growth in good times, but when the economy takes a dip, taking your eye off 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 your brand at a franchise conference. My panel was diverse, but all experienced in franchising. I had representation from a mature franchise system, a multi-unit franchisee, a franchisee lawyer and a franchisor lawyer. Our discussion 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 others 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 primarily focused on franchise system expansion. 

So what should you be looking for during down times that is different than what you're looking at in good times? 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 when needed. 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.
  •  Work with your franchisees to seek adjustments from their landlords on lease payments and terms.
  •  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 your franchisees' financial condition with them. Ensure they are able to meet their obligations, including debt service and payroll taxes.  Advise against "borrowing" from the advertising budget, and to look for savings elsewhere. Cutting advertising most definitely will 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 for 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 the 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 looking for them.

Michael Seid is the founder and managing director of Michael H. Seid & Associates:(http://www.msaworldwide.com/) an international  franchise consulting firm with clients that include both established and new  franchisors.

Michael can be reached at mseid@msaworldwide.com

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