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10 REASONS WHY FRANCHISEES FAIL

by Jason Gehrke,
last updated 12/06/2016

Jason Gehrke has seen some franchisees achieve spectacular success, while others have lost it all. What makes the difference?

Although there is no such thing as a sure bet in business, franchising should help reduce the risks of small business by providing a supported environment utilising both the resources of the franchisor and the community of franchisees operating under the same brand. Choose the right franchise, operate it well, re-invest when required and follow good advice and the results can be very good indeed. Get any of these wrong and the outcome can be less happy.

Of course, franchisees don’t invest in businesses to lose money but, by the same token, they don’t always do enough to mitigate their risks either. If their business fails, the obvious target for the franchisee to blame is the franchisor. On occasion, this is justified; however, franchisees are often the architects of their own misfortune for a variety of reasons that they can’t or won’t acknowledge in time to save the business.

Having been involved in franchising for over 25 years, here’s my top 10 list of causes of franchisee failure. These can occur in any order, depending on the business.

Franchisor causes

Franchisors aren’t perfect. They do get things wrong sometimes, and experienced franchisors are quick to admit it and make the necessary changes to put things right. But sometimes things go so badly wrong that the franchisees really suffer. What should an intending franchise buyer look out for?

1. Bad business model

The franchisor’s business model might be the first thing that franchisees would like to blame for their failure, but this is not always the case. Underdeveloped business models are most likely to be found in new, start-up networks, and this should be factored into a potential franchisee’s assessment of the risks of joining. The risk may be mitigated if the franchisor has used an experienced and reputable franchise consultant, although much depends on how the franchisor actually applies their work.

While the business model risk may be greatest for a new franchisor, it can also re-emerge as a potential cause of failure in mature networks unable to match the pace of change set by nimble competitors, or which have otherwise failed to evolve with their market.

2. Inadequate training & support

Failure caused by poor training or subsequent levels of support is also more likely to occur in newer, start-up systems compared to mature brands. Training and support is typically limited to operational matters in new franchises, with little or no general business training provided.

Franchisees can better protect themselves from training and support problems by determining in advance the nature, content, frequency and assessment of training and support provided by the franchisor (see page 52). If it doesn’t seem adequate, either ask for more, look for additional training outside the franchise (eg. in bookkeeping or business management) or look for another franchise system altogether.

3. Insolvency

When franchisors go broke, often their franchisees will be unable to survive because functions such as marketing, supply chain logistics, IT and other core activities that hold the network together may be wound back or cease altogether. Again, the greatest risk of franchisor failure is among newer, start-up franchisors, but even mature brands can fail on occasion, such as Kleins in 2008.

In New Zealand, many big brand franchises operate under master franchise agreements, and franchisees can similarly be affected if the local master franchisee fails, as happened with Nando’s in 2013. In that case, as often happens, the overseas franchisor took back the New Zealand master franchise and continued to support the franchisees here; however, this is not always possible.

Franchisee causes

Franchisees aren’t perfect either: in fact, they are more likely to be the cause of their own failure than the franchisors. Different challenges arise during the start-up, growth and mature stages of any business, and franchisees need to understand the dangers that each phase brings.

4. Wrong fit

A potential franchisee may experience a franchise from a customer’s point of view and decide that they would like to run a similar business themselves because they love the products or services so much. Unfortunately, there is a big difference between loving the products or services, and managing the challenge of running a business that sells them.

Sometimes, no matter how passionate franchisees may be about the product, the brand or the industry, they are just not suited to the business. They may not be dynamic enough to evolve with the business over time, or may be incapable of managing or retaining staff, or there may be a whole bunch of other reasons why they are simply the wrong fit. Good recruitment and assessment procedures by the franchisor should reduce the risk of being a poor fit, but ultimately it’s not until the franchisee is facing the ongoing challenges of managing their business that their true nature is revealed.

5. Insufficient planning

A failure to plan is a plan to fail. Despite the obvious wisdom of this saying, many franchisees still fail to prepare a business plan before commencing their franchise (on the flip side, many franchisors fail to insist on one either).

A business plan should be a road map that shows the way to achieve profits by setting certain milestones. The franchisor should be involved in the planning process and should analyse and constantly monitor business plans submitted by franchisees to ensure that the franchisee operates their business according to the plan.

6. Insufficient working capital & reinvestment

A lack of working capital and a lack of reinvestment are among the most common causes of all business failure – not just in franchising. Franchisees who start operating businesses without adequate working capital will be unable to pay their bills when they fall due if the amount of cash coming into the business is not greater than the amount of cash going out.

Even if the business is profitable, it can still fail if its customers have not paid on time and it runs out of money to pay its own bills when they fall due. Understanding the difference between cash flow and profit can mean the difference between surviving and failing. Likewise with reinvesting in the business – a failure to do so progressively could eventually result in massive reinvestment works that can send a franchisee broke.

7. Unrealistic expectations

The best way to test whether or not a franchisee has unrealistic expectations about the future of their business is to examine their business plan. This will provide an essential insight into their financial expectations (and when they expect to achieve them), but there may be other unrealistic expectations based around training, support and the flexibility of the business model, among other things.

The problem with assessing expectations in advance is that they are rarely articulated to the franchisor until after the expectations have failed to be met. Franchisees can help protect themselves against themselves by consulting a franchise-experienced accountant from the start – and going on using them.

8. Other distractions

Sometimes the cause of business failure is not related to the franchise at all, but to something else altogether. If a franchisee is comfortable with the performance of their business, they may look elsewhere for a challenge and find another business or interest to keep them occupied. Often, this will take too much of the franchisee’s time (and their money) away from the franchised business to suit the new venture.

Where this occurs, franchisees effectively steal from themselves by taking valuable capital and human resources from one business to support another. When the left hand robs the right hand, both hands risk losing the lot.

9. Complacency, or failure to evolve

The market in which any franchisee’s business operates is constantly changing. If a franchisee doesn’t change with that market, they will ultimately become irrelevant. 

Fortunately for franchisees, they are not alone on this journey of constant change as the franchisor must also evolve to keep up with the market. This should be one of the primary advantages of being part of a franchise system. However, if the franchisee is too complacent about their business or too lazy to adapt to change, their business will inevitably suffer.

10. Failure to follow the system

Despite investing in a franchise with a prescribed and proven way of doing things, some franchisees think they can do it better. Instead of following the systems as used by other franchisees, they try to do their own thing, cut corners or go off at tangents.

Good franchisors are the first to admit that franchisees can come up with excellent ideas to improve a whole system, but if the ideas are completely at odds with the brand offer and values then the franchisee may as well have bought an independent small business instead.

Not only do franchisees who fail to follow the system risk censure and even termination by their franchisor, but they often sabotage their own business in doing so, causing sales and profits to decline.

It’s up to you

This is not an exhaustive list of reasons why franchisees fail, nor are these reasons independent of each other. Sometimes, if a franchisee’s business collapses, it’s easy to identify two or more of the above which combined with deadly results.

So now that you’ve read my top 10 reasons for a franchisee’s business to fail, what are you going to do differently to make sure that none of these happen to you? If you’re buying a franchise, a good place to start is with this list of 250 questions to ask a franchisor. If you already own one, read Glenice Riley’s article on page 32. And whatever you’re doing, always bear this top 10 list in mind. Because you don’t buy a franchise to fail ­– you buy one to succeed.

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