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DO FRANCHISORS CARE ABOUT FRANCHISEES?

by Simon Lord,
last updated 27/11/2015

They can’t afford not to – whatever some people might think, says Simon Lord

I recently read an article by an Australian academic lawyer on the 7-Eleven employment scandal there. Re-published on the New Zealand Herald website, it started with sensible advice about the need for business buyers to do proper due diligence, then veered off into making some slightly strange claims about franchising. Among other things, it suggested:

1. The franchise is created by the franchisor, for its benefit. Franchisors can outsource risk and responsibility to franchisees while retaining the rewards.

2. Franchisees are likely to have invested every last cent into the business. The sunk costs can only be recovered if the franchisee manages to sell the business.

3. Franchisors can change the franchise system at will, so that even if a franchisee does thorough due diligence this might not help them during the relationship.

4. Franchisors hold all of the information about franchisees’ businesses so can see each franchisee in context of the whole system. This absence of context disadvantages franchisees in all franchisor-franchisee negotiations.

Alarm not inform

These points (and others) seem to be a mixture of half-truths and misinterpretations designed to alarm rather than inform. Let’s look at a couple of examples.

‘1. Franchisees are likely to have invested every last cent into the business. The sunk costs can only be recovered if the franchisee manages to sell the business.’

No reputable franchisor would encourage a franchisee to invest ‘every last cent’ into any business, and no professional advisor would suggest that they do so. A business needs to be able to pay its own way and service its own debts, and new franchisees need to allow for cashflow requirements, time taken to reach break-even and working capital in their planning.

In addition, the line, ‘if the franchisee manages to sell the business’ seems deliberately provocative. A business should produce three different types of income for its owner: a fair wage for the hours they put in; a reasonable return on the money invested during ownership; and a lump sum on the sale of the business which, if the business has been well-managed and is successful, should allow for a fair profit.  It’s fair to say that the training and support provided by a good franchise offers franchisees a rather better chance of achieving all this than an independent business owner.

No risk, all rewards?

Another contentious statement is: ‘2. Franchisors can outsource risk and responsibility to franchisees while retaining the rewards.’

That might sound fine in academic theory, but it doesn’t bear much relation to reality. Most franchisors are hugely concerned that their franchisees should be happy, successful and profitable. That’s partly because franchisors feel a genuine responsibility towards those who have invested in their brand, but also because, if franchisees aren’t happy, bad things happen: the franchise won’t grow, customers will leave, competition will take over and the whole franchise – franchisor and franchisee alike – will fail.

Essential change

I’ve just written an article looking at how franchisors in New Zealand have worked to improve profitability for their franchisees since the GFC. Franchisors shared a lot of detail to demonstrate the problems they faced and the solutions they put in place to help franchisees. It’s not just about cutting costs; it’s equally important to develop new, profitable areas of business, and to work together to maximise the value of, for example, group buying schemes.

Some franchisors also talked about the challenge of persuading long-established franchisees to make necessary changes and help them help themselves. The article (published in the latest issue of Franchise New Zealand magazine) gives examples of how a maintenance franchise sold its new range to franchisees by demonstrating increased margins, while a café franchise shows the level of savings achievable if franchisees use preferred suppliers rather than splitting their purchasing power.

Such changes are vital to increasing franchisee profitability, but they can only be developed if the franchisor has access to information from each franchisee and the ability to implement new systems across an entire franchise network. If they don’t, they will lose out to the corporates who have no such limitations. It’s why franchisors retain the right to change the franchise system – not ‘at will’, as the academic lawyer suggests in point 3, but in response to a changing market.

Sharing is caring

And this is the real reason that franchisors gather information about franchisees’ businesses. It’s not to give them ‘the upper hand in negotiations’ (point 4), but to help franchisees improve their performance. By benchmarking the performance of franchisees in key areas such as costs, margins, wastage, staff productivity, return per square metre and a whole host of other key metrics, franchisors can help franchisees achieve a higher return on investment.

If franchisors only cared about the rewards to themselves, they’d only be focused on one thing – the sales figures from which their royalties are calculated. That might be true in a small percentage of cases (the ones that end up in the Law Courts) but it’s not the norm.

For most franchisors in New Zealand, franchising is about creating a win-win. Sadly, bad publicity from overseas cases means others don’t necessarily see it that way.

This article was first published in NZBusiness magazine, November 2015.

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