by Dean Madsen
last updated 02/10/2022
Lessons Of A Lifetime
by Dean Madsen
last updated 02/10/2022
June 2022 - Recently-retired Dean Madsen shares experiences gained from over 20 years in franchise banking
I’ve recently finished up at Westpac New Zealand after 40 years, spending more than half that time specialising as a franchise banker. But I wasn’t allowed to escape that easily – the editor asked me to reflect on what I’ve learned about franchising. Here are some thoughts I hope you might find useful.
My first introduction to franchising came about in the late 1980s when I met a fellow Westpac employee, Pat Everest. Pat was New Zealand’s first specialist franchise banker, and as we chatted over a coffee, he explained that his role was looking solely after franchise businesses – in particular, major brands like McDonald’s, KFC and others. I was immediately fascinated, and visited my local bookstore in Newmarket where I purchased an Australian franchise magazine (it was so long ago, over 30 years, that Franchise New Zealand didn’t even exist!).
I soon discovered there was a lot more to franchising than I had thought, with many brands that I was familiar with, but had never realised were franchises. I also learned some good reasons why franchising was growing so fast. The value of a franchise can be attributed to the strength of the brand, as well as the collaborative buying power of being part of a larger group. I discovered that franchises often had either a technological edge or a process and systems edge over their competitors that allowed them to expand and go on to dominate their specific markets – just look at McDonald’s, which is synonymous with fast service and product consistency, or Pizza Hut and Domino’s, which were delivering meals long before UberEats.
Another key benefit for a franchise chain was that it could grow more quickly using franchisees’ capital to open more stores or operations. Speed of growth can be an important factor when you are trying to gain market share or dominance.
Having worked with a lot of businesses over the years, I could see how all these advantages added up. And, later, when I joined the specialist franchise team at Westpac myself, I was able to help others make use of them – both franchisors and franchisees.
When knowledge plus experience equals success
As a banker, I found one of the major benefits of franchising was the ability it gave us to fund a new start-up business off the forecasts, based on the strength of the benchmarking information provided to the bank about the performance of other franchisees in the same brand. I recall funding an Eagle Boys pizza franchisee in Wellington. He had applied for finance through his usual bank, which had declined him on the basis that he would never be able to sell the forecast number of pizzas in a week. Luckily, the potential franchisee was determined, and contacted me. We spoke on the phone and he sent through his business plan and projections.
I was already aware of Eagle Boys’ growth strategy, and knew that when they opened a new store it picked up some of the customer base from adjoining areas as calls automatically diverted to the 0800 number for the new, closer store. Eagle Boys also carried out a significant marketing campaign when a new store opened, benefitting all the local stores. Based on this specific knowledge of the franchise system, we expected that the store would not just meet the projected figures the other bank doubted – it would probably exceed them.
Sure enough, shortly after opening the new store it achieved sales of around 150 percent of budgeted levels. The franchisor indicated that the franchisee was actually missing a lot of customer calls, and advised them to slow down marketing until another oven and extra phone lines could be added. This was completed a few months later, and the store went on to achieve around twice the original projections. This was a real lesson not just in the value of good data, but also the value that could be added by a specialist franchise banker who really understood a client’s franchise business model.
Grow fast and dominate
Of course, franchises have a life cycle just like any other business. Eagle Boys was eventually bought and merged into Pizza Hut as part of the ‘pizza wars’ of the 1990s. In other cases, I saw market sectors rise and fall, taking franchise concepts with them. Franchisees who got in at the early stage of growth could do very well indeed, and recouped their investment many times over before moving on to something else. That’s still true today, and is a good reason why it’s important for franchise buyers to do due diligence not just on the business itself, but on the whole industry in which it operates.
One such concept was The $2 Shop, a hugely popular retail franchise based on everything in the store costing $2 or less. The original stores were highly successful, but the model was reliant on being able to import cheap priced goods. It worked very well until movement in exchange rates and inflation made it harder to source the same volume of goods. While the franchisor had anticipated this and registered $3 Shop, $4 Shop and $5 Shop trademarks, the change and a huge increase in competition meant the end of the glory days although not before many franchisees made a lot of money.
Another extremely successful franchise model in its heyday was video rental stores. The growth of the industry was linked to the spread of VCR machines and, later DVD players. Video stores were good cashflow businesses and relatively simple to run and manage, which also made them popular with investors. Even some of my banking colleagues were tempted by the figures to purchase and run one or more video stores, and did so very successfully.
The rental industry was dominated by major chains: Civic Video, Video Ezy, United Video and Blockbuster, with very few independents. This illustrated to me how a franchise concept can totally dominate a particular market. A modern-day example might be residential construction, a sector now dominated by large group home builders such as Jennian Homes, Signature, GJ Gardner, Stonewood, Golden Homes, Landmark, etc. While there will always be a place for quality, niche, independent builders, the franchise model offers such advantages that I expect the group home builders to continue to dominate and grow their market share.
What buyers get wrong
While there can be a lot of advantages to purchasing a franchised business, it doesn’t necessarily guarantee success. Of course, there are always risks in business, but in my experience, there are a few things that franchise buyers often overlook or don’t realise.
Some buyers can be prone to underestimating the total finance cost of the business. This can be down to a few areas:
- If the buyer is not purchasing a turn-key business (where everything is included), they can rely too much on the information around the set-up costs provided by the franchisor. It’s always a good idea to check the accuracy of the estimated costs and if they have increased since the franchisor’s last review.
- Not taking into account any working capital requirements. This is particularly important in a business with a lot of stock and debtors. Buyers also need to be aware of how much working capital (cash) is needed until the business reaches break-even and can afford to pay them a salary.
- Overlooking any rental bonds required by the landlord. These can be substantial, and need to be included in finance requirements.
Using information to manage the business
Something else I learned was the importance of managing and understanding financial performance early. While the franchisor will usually have good systems in place to measure performance, some new franchisees were either overwhelmed by the day-to-day running of the store or just failed to manage the financial side. Unfortunately, I have seen new franchisees make significant losses despite achieving great top-line sales by taking too long to get to grips with managing their labour costs or cost of sales.
Another area that can go wrong is if franchisees don’t understand cashflow versus profit. Often, new franchisees who haven’t run a business before would see large sums of cash in their bank account and be tempted to draw out funds without taking into account the implications on tax due, or working capital requirements.
And while not spending unnecessarily is good, failing to re-invest in the business on an ongoing basis is bad. If re-investment on fit-outs, equipment or vehicles is left too long, it can result in a cycle where the business runs down over time. In this case, the business loses value and income, and it becomes more expensive, or too expensive, to catch up on re-investment later on.
How to get it right
The good news is that none of the above is insurmountable – all these problems can be avoided with good management and ensuring you have the right levels of equity when you start your business. It really can be that simple if you take the right advice – and choose a franchise you can realistically afford – to start with.
Ah yes, equity. If I had a dollar for every time a purchaser asked the bank to provide the maximum amount of finance possible so they could reduce their equity requirement, I could have retired years ago! Instead, they should have been asking what is the right amount of equity to reduce their risk? It’s always better to have a little back-up capital in case things don’t go as expected, rather than hoping the bank will bail you out.
The keys to success
So what made some of my franchisee clients more successful than others? While it’s difficult to generalise about so many different people in so many different industries, there are a number of attributes shared by the high achievers.
- They know what their strengths and weaknesses are, and are therefore able to surround themselves with good people who have skills in areas where they are lacking. For instance, if they are not as strong on the financial side, they make sure they have good systems and use their accountant to provide additional support.
- They are driven towards continual learning and improvement.
- They are totally invested in the success of the brand, contribute to it and share information freely with other franchisees.
- They develop their business and their staff to a level where they can work on their business and not just in it. Generally, these franchisees are good people managers and great at motivating staff. A lot of my best clients devised incentive schemes or gave a senior staff member an equity stake in the business to give them ‘skin in the game’. That’s a good plan for future succession, too.
Over the years, I’ve had the pleasure of working with a lot of franchisors and franchisees. I’ve also worked with a number of franchise experts such as lawyers, consultants, accountants and bankers who are passionate and have a great understanding of the franchise sector.
What I’ve learned is that the more you know, and the better the advice you take, the higher your chances of success. The highest-performing franchisees know that too. So if you are looking to buy a franchise – or even to start your own franchise – you can’t go wrong by getting in touch with people who really know about franchising. The Advisors section in the Westpac Directory of Franchising on this website is a good place to start.
Oh, and to Westpac, and everyone I’ve met in franchising? There’s a wonderful community spirit about franchising, and it’s been great to be a part of it. Thank you all!
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