Franchisors and franchisees shouldn’t fool themselves

These are your mum and dad franchisees that have their life savings tied up in the franchised business. If they can’t find a buyer for their business or if their franchised business fails, then they lose everything.

There is no shortage of horror stories where the poor mum and dad franchisee have lost everything. Sometimes even the poor franchisor loses everything. Here the moral of the story is that franchised businesses fail just like any other business. And in the tough times we are currently facing it won’t be surprising to hear of more franchising failures.

Franchisors and franchisees should never fool themselves into thinking they can’t fail or are less likely to fail. While for many people franchising is seen as glamorous and rewarding, the reality is that sometimes franchising can become a nightmare.

Put simply, franchising is not for everyone. Some franchisors and franchisees should never have gotten into the franchising game. Sure, there are successes, but those successes are of little or no comfort to those franchisors or franchisees that have ended up losing everything.

Given the tough economic conditions it’s hardly surprising that some franchisors and franchisees are going to fail. That’s why anyone wanting to invest in franchising needs to do a great deal of homework. The days of a person going to a franchising expo and immediately signing up to become a franchisee should be long gone.

For the potential franchisor it’s obviously critical to be adequately funded. With the major banks pulling back from lending to businesses or inflating interest rates on business loans, potential franchisors need to be sure they can get access to affordable finance.

A lack of affordable finance is the kiss of the death for not only the potential franchisor but for all those existing franchisors out there struggling to refinance business loans with the major banks.

Not only are there growing numbers of franchisors who are feeling the credit squeeze by the major banks, but there are franchisors that don’t have the critical mass to self fund their expansion. That will inevitably put pressure on those particular franchisors and obviously potential franchisees should avoid those franchisors.

A lack of affordable finance is also hitting franchisees very hard. With many franchisees paying inflated retail rents in shopping centres that were set in the pre-GFC days, it’s clear that for a growing number of franchisees it’s even a struggle to fund their everyday business needs.

With the many pitfalls associated with franchising, it’s clear that those thinking of being franchisees should be careful to avoid franchisors that are not financially secure. A reasonably good indication of the franchisor’s financial viability is to look at how many franchised outlets with the franchisor’s name are on the market.

The more franchised outlets on the market as a result of existing franchisees trying to sell their business, the more alarm bells that should be ringing for the potential franchisee. The real danger here is that existing franchisees are rushing to get out before it’s too late.

We should never forget that generally few people rush to get out of something that’s making them lots of money. That’s why we need to ask lots of questions if there are lots of existing franchisees trying to get out. 

Any potential franchisee should go have a chat with lots of ex-franchisees. Obvious questions include why did the ex-franchisees leave the franchise? Would they buy back into the franchise? How supportive was the franchisor? Obvious alarm bells should be ringing where ex-franchisees can’t be located or whether they are too glowing in their feedback. If the franchise was that good why did they leave?

Inevitably, there are pitfalls in all franchises and it’s important to get the full picture regarding any problem areas so that any potential franchisee can make an informed decision. There’s no point buying a franchise if you end up with a dodgy franchisor.

Another danger area for both potential and existing franchisees is where the franchisor requires franchisees to buy goods or services from particular third parties especially if the third parties are related to the franchisor, or the third parties charge inflated prices for the goods or services. The real danger is that the inflated prices for the goods or services will, in turn, inflate the price of products sold by the franchisee. That makes the franchisee uncompetitive.

Just imagine being a franchisee who sells ice cream and the franchisee is required by the franchisor to buy ice cream ingredients from a third party that charges high prices for the ingredients. Of course, the franchisor will claim that the ingredients will be of “superior” quality but what if the franchisee’s ice creams are then significantly overpriced as compared to competitors?

What if you have McDonald’s franchisees selling ice creams at 50 cents each and the ice cream franchisee nearby sells them at $3 each. You guessed it. You might find many of those uncompetitive ice cream franchisees trying to sell their business or simply failing.

As with any business opportunity the level of investment in that opportunity depends on the level of confidence that investors have in the opportunity. With franchising there’s a very real danger that the tough economic conditions and the growing number of franchising failures will scare off potential franchisees.

In franchising there’s also the very real danger that potential investors lack confidence in the current regulatory environment. In fact, while there’s a Federal Franchising Code of Conduct that’s there to regulate the conduct of franchisors, the Federal Franchising Code is not backed by direct financial penalties for breaches of the Code.

Yes, that’s right. There’s a Federal Franchising Code that’s there to try and protect franchisees but the Federal Labor Government has repeatedly failed to back the Code with direct financial penalties where franchisors breach the Code.

We know there have been breaches of the Federal Franchising Code, but previous Federal Small Business Ministers like the singing Craig Emerson and the equally forgettable Nick Sherry have refused to reinforce the Franchising Code with direct financial penalties.

Let’s hope that the latest Federal Small Business Minister, Brendan O’Connor, follows the excellent lead of the South Australian Small Business Minister, Tom Koutsantonis, and moves quickly to impose direct financial penalties for breaches of codes of conduct such as the Federal Franchising Code.

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