Legal & Financial Advice

by Win Robinson

last updated 19/08/2019

Win Robinson is a Past Chairman of the Franchise Association of New Zealand and is the (now retired) founder of Franchize Consultants (NZ) Ltd. He was both a franchisee and franchisor prior to becoming a franchise consultant.

What makes some go boom and others go bust

by Win Robinson

last updated 19/08/2019

Win Robinson is a Past Chairman of the Franchise Association of New Zealand and is the (now retired) founder of Franchize Consultants (NZ) Ltd. He was both a franchisee and franchisor prior to becoming a franchise consultant.

Why do some franchise networks build on their success while others go downhill? Win Robinson shares some secrets and asks the provocative question 'Is your franchisor making enough money?'

We acknowledge excerpts taken from the Commonwealth Bank and the Franchise Council of Australia publication The Complete Guide to Franchising, denoted in inverted commas within the text.

When a successful existing company starts to franchise, it means making a lot of changes. The fast food restaurateur in no longer just in the business of providing a good product; the courier company has to be able to transfer those skills to others in a manner which is profitable for all concerned. So there will naturally be many things for the new franchisor to learn.

While there are several sources of advice available, intending franchisors are often disappointed to find that there is no one right way of setting up a franchise. As Professor Andrew Terry puts it in "The Complete Guide to Franchising" published in Australia by the Commonwealth Bank:

"A business format franchise model is not a standard model which fits neatly into a pre-determined template. The great strength of business format franchising is that it delivers to the consumer a standardised and consistent product or service. It is not itself a standardised commodity and there is great variety in the nature and operation of business format franchise systems and the sophistication of the prescribed business format and systems."

There are, however, a number of essential elements to be found in every business format franchise, and these must be set up in such a way as to provide mutual benefits to both franchisor and franchisee.

"Irrespective of the attractiveness of the business to the consumer marketplace, a franchise system cannot survive if the detailed internal relationship between franchisor and the franchisees is not balanced and appropriate. A proven and attractive concept will fail if the internal aspects of the system are unsatisfactory. In the absence of a balanced relationship, both in terms of service provided and a financial package which offers appropriate returns to both parties, there is little hope of a long term relationship from which both franchisor and franchisee benefit."

In essence what this is saying is that to be a successful franchise, an appropriate franchise format must be worked out for each individual business. There is no way that a business person can copy someone else's franchise format and expect it to work for them. Each franchise format and system must be individually tailored to the specific purpose or set of objectives that the franchisor desires. The better designed the format and systems, the better the franchise operation should work.

Is the franchisor making enough money?

That's an interesting turn around, isn't it? You often hear people in franchising saying "If the franchisor ensures that the franchisees are successful, then the franchisor in turn will become successful".

But this statement is only true where the franchisor has structured the franchise business properly. If the franchisor's business hasn't been set up with an appropriate format, the franchisor may not be making a profit - and indeed may even be losing money - by carrying out some of his obligations under the franchise agreement.

In simple arithmetic, if the cost of performing a franchisor's obligations exceeds the income from the franchisees the result, as Mr Micawber would say, is unhappiness. Unhappiness for the franchisor, who will hardly be motivated to help the franchisees, and unhappiness for the franchisees, who may end up with a failing franchise system despite individual successes.

It is therefore important that franchisees understand that the franchisor needs to make a profit. If the business is not structured in such a manner that there is enough income to fund support services, then those support services cannot be provided long-term - no matter how good a franchisor's intentions.

About eighteen months ago, a franchisor came into our consultancy and told us that he would like to improve the performance of his franchise operation. He said that he didn't know specifically what was wrong, but he knew things weren't as good as they should be. We undertook a 'health check' on the business. It is just as well that he sought assistance when he did, otherwise his franchise would not have lasted more than two years - and quite possibly less.

This franchisor had a reasonable franchise agreement which clearly set out the rights and obligations of both parties and covered other vital points. However, in carrying out the franchisor's obligations under the agreement, the cost was exceeding the income from the franchises. His own retail outlet was subsidising the franchise system.

This is not uncommon in the early days of franchising a business - the franchisor cannot achieve break-even until he has recruited a certain predetermined number of franchisees who in turn are operating at a certain level of sales. In the interim, either invested funds or the cashflow provided by the base business must fill the gap. In the long term, though, providing services which the franchisees' contributions are not paying for is a recipe for slowly but surely going broke.

In the above case, a restructuring of the basic format and the correction of a number of other problems resulted in a complete turnaround of income - leading to a healthy and growing profit for the franchisor, and sustainable services and improved security for the franchisees.

Another franchisor came to see us knowing that his system was in trouble. It had been copied from another franchise business which was operating in a similar field. Both the format and the system were not appropriate for this particular franchise, however. The sad part was that part of the problem was that the franchisor was loving his franchisees to bits, actually over-servicing them. Here again the franchisor was losing money on the operation and if no action were taken it would be just a matter of time before the inevitable happened.

And if these two examples aren't enough, let me mention the most famous one of all - McDonald's. As originally set up by Ray Kroc, the level of services promised by McDonald's to its franchisees cost more than the fees it charged them. In the US, at least, they still do - McDonald's collects 3% of sales in service fees from franchisees but the cost of servicing the system, from market research to product development to field support, totals around 4% of all sales. The difference (and the company's profit) comes from its real estate and sub-leasing operations.

Accordingly, it is important for a franchisor to work out some financial models at various levels of activity so that he establishes what he needs to do to start operating in a positive revenue and cash situation. This applies as much to existing franchises as new ones - situations change.

Franchisor services

Let's look at some of the typical services that the franchisor needs to provide in order to ensure that the franchisees have the best chance of success.

  • Training: It is most important that new franchisees are taught how to run the business and apply the systems properly. This may be done in a concentrated effort at the beginning of the franchisee's term, but it could also be continuous over a number of months, and may entail numerous refresher or updating sessions.
  • Monitoring progress and ongoing advice: It is important to collect vital data from the franchisees, be able to process that data correctly and then feed it back to the franchisees in a meaningful and helpful way. Benchmarking and measuring progress are vital to the development and improvement of the franchisee, the franchisor, and the franchise system. With the franchisor's experience and thorough knowledge of the business he will be able to establish the correct KPI's (Key Performance Indicators) for both the franchisees and the franchisor to operate by. According to what the KPI's show, a franchisor will advise the franchisee on the best course of action to keep them on course and meet the objectives detailed within each franchisee's business plan.
  • Continuous improvement and development of the operating system. This is often reflected within updates to the operating manuals and associated systems.
  • Research & development on products and services offered (including trialling or testing).
  • Conduct national advertising campaigns and other promotional activities. While promotional budgets are often collected as a separate fee, the employment and other costs of marketing staff and management must be paid for.
  • Monitoring of standards.
  • Protection of intellectual property.
  • Generating business/contracts or referrals.
  • Stationery and marketing material development and/or supply.
  • Site visits at appropriate intervals.
  • Arranging meetings of all franchisees at predetermined intervals, and the arrangement of an annual conference.
  • Developing relationships with suppliers including preferential pricing arrangements and ensuring they are passed on.
  • Providing software updates and assisting with their implementation.

The list of franchisor obligations can go on and on depending on the type and nature of the franchise.

Devising the optimum level of support required for each franchise system is a complex process.

"Operational Support - a wide concept including ongoing training, assistance, servicing system development, marketing and so on, across all aspects of the business is another key factor. There is no one standard of operational support as different franchise systems have different requirements. Successful franchise systems provide that level of ongoing support appropriate to the needs of the franchisees. Management must be flexible, forward thinking and be receptive to a co-operative culture," says Andrew Terry.

With a new business, the likely costs of a franchisor fulfilling his obligations to the franchisees and the system will not be known until some comprehensive financial modelling has been done with costs and likely outcomes fed into the equation. In the early stages of growth of a franchise chain, much of the franchisee servicing may be performed by the franchisor or his existing staff. However, as the chain gets bigger, the franchisor will have to hire more staff such as a franchise manager or field officer, or he may contract out some of these specialist tasks.

These events must be anticipated and factored within the initial financial model and thus become part of the working budget. The consequences of not doing a proper feasibility study and development plan can be, and usually are, very hurtful indeed. Not only can the franchisor trade himself out of business and lose all his investment, but the franchisees can also lose their businesses.

If a system has already been set up and the franchise network is in operation before it becomes apparent that all is not what it should be, a franchise audit is required. This involves someone of experience taking a 'snap shot' of the franchise operating situation. Once the cause of the problems is determined, the answers can be worked on.

In an established franchise, sometimes finding the answers is the easy part - it's implementing them that is difficult. In most cases it will mean involving the franchisees, explaining the nature of the problem and getting them to co-operate in the solution for the long-term good of the entire system.

This is not necessarily simple if the solution involves the franchisor collecting greater revenues to deal with specific issues or the reduction of services previously included under the franchise fee. However, there are proper ways and techniques of persuading franchisees first to recognise the importance of correcting the problem, and secondly agree to co-operate and implement the new requirements. Leadership Style

Having said all that, there is another factor that comes into play once franchising has begun and that is the style of leadership of the franchisor.

As I said at the beginning, there is a huge difference between successfully running your own business in whatever field and managing a franchise chain. To start with, the structure of the franchise operation will be very different from that of the original business. This applies to both the small trader and the large corporate.

The small trader will probably face for the first time a much greater number of people to direct. There will be, or should be, certain predetermined channels of communication that must be observed. There could be several people involved, each responsible for various operational or information functions but all having to mesh in with the other cogs in the big wheel. The fast-moving risk-taking style of the original entrepreneur will often not be appropriate in such an organisation.

Meanwhile, the new corporate franchisor who has moved from managed branches to franchised outlets may have to adapt from a very dictatorial, vertical hierarchy to that of a much flatter and persuasive type of structure and management style.

I have noticed with some corporates that when they first start franchising they certainly pay lip service to the proper technique of persuading franchisees with reason and logic to follow a certain course of action. However, as time goes on and if things perhaps get a little tougher than anticipated, they may revert back to their old corporate style of telling or ordering the franchise chain about. This has adverse repercussions and can eventually be very destructive for the whole group - after all, franchisees do own their own businesses and don't expect to be told what to do.

Intelligent franchisors will listen to feedback from franchisees and be responsive to their leadership needs. Organising a Franchise Advisory Council from early on in a system's growth is an invaluable way of tabling concerns, addressing issues and creating understanding of everyone's needs and wants without the franchisor abdicating responsibility or losing control.

Call for help

Over the years, I have heard many stories from franchisees and franchisors which tell me that either their franchise support system is suffering from a less than optimal format and system, or that the way the franchise is operated is incorrect. Some of the franchise companies that I have heard about will fail, with awful consequences. Apart from the loss of capital and reputation of the franchisor, many of the franchisees may be badly affected with some of them possibly losing their life savings.

I believe that some franchisors won't admit that they have a problem, while others stumble on hoping that things will miraculously come right. The good news is that in most cases the franchises concerned can be redirected along the right lines, and that even in very bad cases most can be salvaged. It takes honesty and courage for franchisors to seek help. But not getting the appropriate assistance is too awful to contemplate.

Where can a franchisor get assistance? Being a member of the Franchise Association of New Zealand will enable you to tap into the wealth of experience of many of New Zealand's most experienced franchisors. All have made their own mistakes and learned from them, and you may be surprised at how prepared they are to share that information with you. The Association also publishes The New Zealand Franchisor's Guide which provides guidance particularly with setting up and establishing a franchise operation.

Banks with franchise divisions employ people knowledgeable in franchising as well as financial matters. If you use your bank as part of your team and work with them closely, you will get the most benefit. Through their experience they know what certain key financial operating ratios should be, and will be very willing to provide advice.

Accountants and lawyers have much to offer within their areas of expertise in both the set up of franchise operations and in keeping the network on track. Mediators can help to resolve problems in the franchisor/franchisee relationship in an amicable and constructive way. Choose advisors who have experience in franchising and are pro-active in their approach.

There are franchise consultants who not only develop new franchise systems but who also specialise in the full ongoing operations and management of franchise businesses. Such people know how to arrive at an appropriate format and have experience in developing workable systems,. They can help formulate performance indicators and benchmarks to keep a franchise business developing, innovative and profitable.

To put it simply, franchising is a whole set of new skills that have to be learned and then applied appropriately. This is no mean task, and the franchisor needs all the assistance and experience he or she can find. If you have concerns don't be afraid to call for help. It not only pays to seek professional advice but is a cost-effective insurance policy for the good health of your entire franchise business.

Win Robinson is a Past Chairman of the Franchise Association of New Zealand and is the (now retired) founder of Franchize Consultants (NZ) Ltd. He was both a franchisee and franchisor prior to becoming a franchise consultant.

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