Protecting your System in a Challenging Economy
By: Edward (Ned) Levitt

I wonder how many millions of times someone has said, "an ounce of prevention is worth a pound of cure". Well worn or not, that adage could not be more accurate than when managing a franchise system in this challenging economic environment.

As the financial reality for most franchisors changes when the economy softens, it is vitally important for franchisors to more frequently monitor their own financial circumstances. Some predictable changes will include diminished royalty revenues, falling revenues from corporate stores, reduced volume of franchise fees from franchise sales, increased demand for resources and support from franchisees, increased legal costs in dealing with franchise disputes and closures, growing accounting costs to monitor franchisees and a possible increase in extraordinary payments such as payments to landlords to terminate redundant leases.

Another hallmark of a weak or weakening economy is the unpredictability of revenues and costs or even the availability of necessary inventories, supplies and materials. As a result, the risky business of projecting revenues, costs and profits becomes even more risky.

A franchisor must be careful about making revenue, cost and profit projections. Sometimes these forecasts are necessary, since certain franchisees may not even consider investing without some disclosure of earnings estimates. In these situations, forecasts should be significantly qualified by geographic, demographic, seasonal, market and technical factors as appropriate. More often, the franchisor will choose to avoid these touchier areas altogether, and instead include historical earnings with the warning that historical data provides no assurance of future performance.

In order to get a better handle on the franchisor's financial health, it is critically important for the franchisor to know the financial health of its franchisees. A well drafted franchise agreement gives the franchisor the legal tools to require disclosure of financial performance from franchisees and access to their records for verification.

In tough times, franchisors must be more vigilant in demanding strict adherence to rules on purchases, financial disclosure and timeliness of payments from franchisees, all of which may have become lax during buoyant economic time. Franchisors can also look to cost cutting measures at the head office such as reducing staff and ridding itself of leases and underperforming locations. Making the tough decisions sooner than later may lead to a better long term outcome.

There is no more important a time to take action against franchisees who do not follow the rules of the system or who are fomenting discontent among other franchisees. Assisting franchisees who are not likely to survive or who are more destructive than they are worth to exit the system may be the best strategy. Franchisors must be willing to act more deliberately and in a more timely fashion than would be necessary if broad economic challenges did not exist. This tough environment requires the franchisor to dip deeply into the well of wisdom and make some hard decisions that may save the majority of franchisees and the system itself.

The "culling" process can take many forms, each of which involve very different skills, resources and strategies. If possible, negotiation should be the first step in helping to resolve problems or disputes followed by the exercise of self-help remedies such as withdrawal of support, termination of supply arrangements and a re-taking of premises.

On the other hand, offering to assist the troubled franchisee in reselling his franchise to a better or better financed operator is a sound strategy in troubled times. Good franchisees, who are well enough financed and already in the system, may see this as a unique opportunity to grow. Re-sales to existing franchisees have the lowest cost to the franchisor of all franchise sales, since the selling costs and training costs can be very little or nothing at all.

Sometimes, franchisors try to sell their way out of difficult times. When cash is tight, initial franchise fees look very attractive. However, sound franchise theory dictates that the initial franchise fee should compensate the franchisor only for its true costs in securing the franchisee, the location or territory and in helping the franchisee establish the business. It is mostly an act of cannibalism of the franchise system to sell franchises without devoting the necessary resources towards ensuring quality in such things as franchisee selection, site selection and training.

Survival of a business is not assured no matter what strategies are used. However, there is much that can be done to tip the scale in favour of survival. Awareness of your franchisees' circumstances and honest attempts to address their difficulties can be the determining factor in the survival of your franchise system.