How to Identify A Franchise That Might Fail

Keeping your concept, capital and management in check will keep your new franchise from going bankrupt.

How to Identify A Franchise That Might Fail

So why do some franchisors fall upon hard times while others prosper? Here are my top three reasons for franchisor failure: concept, capital and management.

At the Core: The Concept

In franchising, it always starts with the concept. Some franchisors start franchising before they’ve properly refined the concept – much to their own detriment, as well as the detriment of their franchisees, investors and bankers.

No concept is beyond failure. And franchisors have competing interests: They want to be sure their concept is fully refined, but they also want to be the first to market if they have a unique concept.

At a minimum, the franchisor should remain confident that a properly trained and supported franchisee who follows the system will achieve a rate of return that’s commensurate with his or her risk.

That said, it’s important to recognise that markets change over time. Thus the relevance of a concept within a market could also change.

Don’t overlook the importance of investigating franchises with a high number of non-franchised units in their chain. One of the big advantages to company-owned growth is that the parent company keeps every cent that goes toward the bottom line. But it also absorbs every loss its corporate stores generate.

If corporate store losses are in excess of the royalty (and other) revenues generated by franchisees, the parent company may not be able to survive – even if its franchisees can. Moreover, when a marketplace changes, franchisees that are doing poorly will not validate well – making it difficult for the franchisor to sell additional franchises or divest itself of its corporate stores, further exacerbating cash flow concerns.

To avoid such problems, many franchisors will carefully evaluate their risk exposure when planning the development of corporate locations. And, of course, they’ll always make sure their primary focus is on unit-level profitability, because they know that without a concept that works for everyone – from the consumer to the franchisee to the franchisor – franchising is destined to fail.

The Unifying Factor: Management

Given the importance of capital and concept, it’s hard to believe that there could be an even more important factor affecting franchisor success. But the truth is that the majority of franchise failures are a result of bad management.

Think of it this way: Great management will make concept adaptations quickly to help ensure the success of both franchisees and company-owned units – and will not franchise a concept that isn’t ready for that step. Great management will find capital when it’s in short supply or when more aggressive growth plans are called for. Without this capital they’ll keep their growth at a level their capitalisation can withstand.

But, no matter how good the concept and no matter how well capitalised the company, bad management will find a way to destroy the business.

Bad management manifests itself everywhere, in a lack of vision, systems, standards, motivating, communication, measurement, accountability, enforcement and nepotism.

The best managers – and owners – know this and go in with their eyes wide open. They’ll critically examine the concept and their marketplace before making such a profound strategic decision. They’ll carefully monitor and conserve their resources; even if that means they must slow their growth to a level below what the market might support.

But most importantly, before doing anything, they will start by directing their critical vision inward to be certain they have what it takes (or can obtain what it takes) to achieve the success they’re planning.

A 9-Foot Leap Across A 10-Foot Ditch: Capital

Unfortunately, the set of circumstances that often drives people to franchise in the first place – capital – can also be a culprit in some franchisor failures. While franchising is a low-cost, low-risk means of expansion, it’s not a no-cost, no-risk means of expansion.

New franchisors will have significant legal and development costs associated with the creation of their franchise programmes. They’ll also need to budget adequate working capital for the start-up phase.

Working capital will fall into two major categories: personnel and franchise marketing. Neophyte franchisors may under-allocate in both areas, thinking they can simply finance growth out of their franchise fees.

And while some franchisors may achieve this feat, the franchise graveyard is littered with those that didn’t understand that faster growth requires significantly more initial capital – as franchise royalties will often take months after the initial sale, to start flowing with any regularity.

The same principles hold true for established franchisors. New franchisors may tend to start slowly, thinking that once they’ve sold a few franchises they can accelerate quickly. More fuel is burned when accelerating than when simply maintaining your speed.

Moreover, when concept difficulties are combined with undercapitalisation, the faster growth comes, the worse the problem becomes. Fast growth, by its very nature, requires more capital. But it also more rapidly deploys the limited capital of franchisees.

If a franchisor needs to go back to its franchisees to make modifications to the underlying system, it’s more likely that these franchisors may have neither the capital nor the inclination to do so. These disaffected franchisees are likely to validate poorly and will generate less revenue for the franchisor – again exacerbating the problem.

Franchise Zone
About the Author
Franchise Zone is published by Entrepreneur Media SA. It offers advice and franchising opportunities in South Africa.

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