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The good, the bad and the ugly

Written by: Rod Young

Article Overview: The Good with the Bad ...what are some of the disadvantages of franchising you should prepare for? There is no better or safer way for an inexperienced person to get into business than franchising. It is also a most attractive opportunity for more experienced business people to combine their previously learned business skills with a franchisors brand, systems, buying power and market knowledge to generate a degree of profitability that many independent competitors would envy. However, whether you are an experienced businessperson or an employee yearning to be your own boss, you must understand that the franchised business model is not in a guarantee of success. Franchising Magazine asked Rod Young, Executive Director of DC Strategy to identify the disadvantages of franchising and provide a perspective.

The good, the bad and the ugly

While franchising is a low risk method of entering and conducting business for a franchisee, franchised businesses can and do fail. Before you enter it into a franchise arrangement you must consider the disadvantages in a franchise relationship, including the major disadvantage of going into any business; the possibilities of losing the capital and/or assets you have invested in the business.

Franchising – Your Own Boss but Not on Your Own
In talking with franchise owners who had disputes with their franchisor, or who suffered substantial setbacks and failure, many had only considered the advantages of franchising before they signed the franchise agreement, but had not contemplated the unique obligations that a franchise relationship places upon a franchised owner operator in comparison to an independent business. A totally independent owner answers only to themselves, whereas a franchisee has obligations to the franchisor, fellow franchisees and to the business system under which the franchise operates.

Like any business model, franchising has both advantages and disadvantages. In considering whether franchising is the right way for you to go into business, understanding what the disadvantages of franchising may be can lead to a better understanding of the franchising business model, better decision-making and as a result, a more fulfilling business life as a franchisee. With planning, the right strategies and foresight, many potential downsides can be kept in perspective, and successfully managed.
Depending on your perspective, the disadvantages of franchising revolve around the obligation to follow the franchisor's system. The disadvantages in franchising may include;

Restricted Location or Territory
Most franchisors will require franchisees to operate only one franchised business from a specific location or inside a territory approved and/or specified by the franchisor. In some cases, there are no territories, and any franchisee in the franchisor's network can conduct business by competing with other franchisees for the same clients. This has the potential to limit the opportunity a franchisee may have to open other stores or mobile units, promote the franchise, or may result in better franchisees taking business away from poorer operators in an unrestricted territory models.

Sell Only Specified Stock and/or Services
Franchise owners are often restricted to selling only stock and/or services specified or approved by the franchisor and in some cases, may only buy that stock or service from the franchisor, and no other third-party. Furthermore, the franchisee may be required to carry specified quantities of certain stock items, regardless of turnover.

Attend Meetings and Conferences
A common feature of many franchise systems is it that franchisees are required to attend meetings specified by the franchisor, often at a location specified by the franchisor, within a specified period after getting notification of such a meeting, at their own expense. This often includes a specific requirement to attend conferences that may be in exotic locations many thousands of kilometres from where a franchisee operates the business.

Advertising and Promotions
The franchisee may be required to participate in a promotion as part of a national campaign even though the type of promotion or pricing policy may not be appropriate for his or her particular location. While the franchisor, at his discretion, may appoint franchise owners to an advertising committee, there is often no obligation for the franchisor to comply with any recommendations or decisions made by this advertising committee.

Franchisors Holding Head Leases
In the majority of retail networks, the franchisor or an associate company will hold the head leases of the premises from which the franchised business is conducted, and thereby control the location in which the franchisee operates. While franchise owners usually have a licence arrangement to provide security of tenure, the franchise agreement and the occupancy licence are often linked so that a breach of one agreement will automatically breach the other. This could mean that a breach of the occupancy licence could not only result in the termination of any occupancy rights, but may automatically lead to a termination of the franchise agreement. Alternatively, a breach of either the occupancy licence or the franchise agreement resulting in termination of the franchise agreement may give the franchisor the right to take possession of the premises, buy back the franchisees fixtures and fittings and stock for their written down value, and either operate the business as a company-owned store or resell it to a new franchisee without the payment of goodwill or refund of franchise fees.

Restricted Term and Tenure
In most franchise arrangements, a franchisee does not own the franchise for an unlimited period of time, but, more correctly, has the right to conduct the business and exploit the franchisor's intellectual property for a specified timeframe. In many cases, this initial period is followed by an option period of about the same time. At the end of this initial or option period all rights under the agreement come to an end and unless a new agreement is entered into, the franchisee has no rights to remain on the premises, or to sell the business.

No Control over Business Concept
Franchisees do not have any right to change the business model, products, menu or services or the design and colour schemes of the business, regardless of the merit of doing so. Unless the franchisee can convince the franchisor that the concept, marketing ideas, stock mix or business look and feel needs to change, the franchisee must operate the business as specified by the franchisor.

Sale and Assignment
The franchisee may be prevented from selling the business to the person that is willing to pay the top price. In the event the franchisee wishes to sell the franchise, most franchise networks specify that the franchisee may only do so by following a specific procedure, which often includes a timeline and a requirement to offer the business to the franchisor on the same terms and conditions as was offered by a prospective purchaser. Most franchise arrangements have the ability for the franchisor to decline the application of a prospective franchise buyer if the franchisor feels that any prospective buyer does not meet the franchisor's current standards, and in effect, can prevent the franchisee from selling the franchise to that buyer. Some assignment provisions having the effect of requiring the incoming franchisee to enter into the then current terms and conditions of a franchisor's agreement, which may include increases in royalties, advertising contributions and other specified payments in the franchise arrangement or changes in territory.

Restrictions on Other Business Activities
Many franchise systems require the franchisee to devote the whole of their time and attention to the conduct of the franchised business and not be involved in any way in the operation of other businesses, in some cases, even if those other businesses do not compete with the franchisors business concept.

Financial Reporting and Benchmarks
It is not unusual for franchisor is to require a franchisee to report the performance of the franchised business on a weekly, monthly, quarterly, and annual basis in a specified format. Some systems post these details on an internal intranet, allowing all franchise owners to compare their operating performance with other franchisees. This could result in the financial performance of your franchise being seen by people other than those directly involved in the franchised operation.

Minimum Performance Requirements
Franchise systems expect that in exchange for granting the rights to exploit a franchisor's intellectual property and use the franchisor's business systems from a location or within a region, each franchisee must achieve a minimum threshold of financial and/or operational performance. This may be specified as a minimum amount of gross sales to be achieved each month, quarter or year. In the case of operational performance it may be an average ranking above a specified level of performance as measured in, say, a mystery shopper survey. Failure to achieve these minimum performance levels may result in a requirement to make a minimum royalty payment regardless of the turnover achieved or an obligation to attend the franchisor's head office for retraining, if certain operational thresholds are not being achieved.

Trading Hours
It is unusual for a franchisee to have the luxury of choosing the opening or closing times of his or her business, or indeed the days of operation. Many franchise systems promise the consumer a seven day per week opportunity to buy goods and services, and the franchisee is compelled to offer those goods and services over the entire trading period that the franchisor has specified in the franchise agreement. Few, if any, franchise arrangements would allow a franchisee to close down the business in order for the franchisee and his family to go on holidays. The obligation to keep the business open during the specified trading hours and days lies squarely on the shoulders of the franchised owner operator.

Right of Access to Premises and Records
To ensure that a franchise owner is conducting the business in an appropriate manner and following the franchisors business methods, most franchise agreements contain a right for the franchisor to attend and enter the premises from which the franchised business is being conducted. Some agreements may require no notice at all and provide the franchisor or his representative with the right to not only inspect the operations but also, conduct a stocktake, audit invoices and any other financial records including tax returns, and to interview staff.
Your Commercial Judgement of the Disadvantages

When reviewing some of the disadvantages of franchising it is now time to bring some perspective to your decision-making about whether franchising is right for you, and to test your commercial judgement. As can clearly be seen, entering into a franchise agreement brings with it substantial performance obligations. If a franchisee fails to honour or performed some of these obligations the commercial arrangements between a franchisor and the franchisee could result in a franchisee having his or her franchise agreement terminated and the business operating under that franchise agreement being closed down or, in effect, repossessed.

Why is it that, even with all these commercial obligations and disadvantages, franchising is still a substantially better and lower risk way of going into business when compared to independent ownership? Independent businesses have none of the contractual obligations such as those detailed above, yet the risk of failure is higher than franchised businesses. Average sales and profits in independent businesses are generally lower and most franchised businesses are more valuable than their independent counterparts.

The Myth of Independence
Often people go into business to “be the boss”. Sick of working for somebody else, and being told what to do, they seek the “independence” of being in business for themselves, wanting the freedom to set the rules, work when they want to, and be answerable to no one.
Most that go into business with this misguided view are soon greatly disappointed by the demands a business places on them, and the attitude of their staff, suppliers and customers. Some never learn how to operate a business, and many of these fail.

A business, whether franchised or not, can be a demanding mistress (or toy boy), requiring skill, care, passion and love and attention lavished on her or him repeatedly and consistently over many hours every day from the first time you open the door. The customers are the sisters (sometimes ugly sisters) and brothers, demanding individualised attention to placate them and keep them loyal.
The reality is that you will never be truly independent as a franchisee. The franchising relationship is similar to being part of a community, a team or a family. Just as any team needs discipline to be the best, the rights of the individual franchisee need to be tempered for the good of the group to ensure success.

To get the so-called disadvantages of franchising in perspective, any prospective franchisee needs to understand that any quality franchisor has developed systems and processes that are proven to create a satisfied “mistress” and make raving fans of her siblings. At the same time, franchise arrangements need to control what might be a rogue franchisee in the next suburb that is compromising the brand, your business and your future.

A Question of Balance
Yes, franchising does have its disadvantages, its disciplines and commercial obligations. However, in best-practice franchising, these potential disadvantages are not imposed to create a one-sided arrangement that limits opportunity. If the franchise system is professionally developed and the commercial policies and franchise agreement are focused on enshrining conduct that has been proven by the franchisor to be the foundation of the success of the franchisors business model, and these conditions and obligations are imposed on every franchisee in the network, then the foundations for successful franchising are in place.
Your commercial decision comes down to this question:
Will the disadvantages of franchising imposed upon you by the franchisor, the franchise agreement, and the franchise relationship, and the disciplines they will require for compliance, hinder or enhance the potential of maximising profitability and capital gain?
After weighing the pros and cons only you can answer that question.

Rod Young is the Executive Director of DC Strategy.
DC Strategy www.dcstrategy.com (formerly Deacons Consulting) is widely recognised as the region’s leading Strategy, Franchising and International consulting group. DCS has developed the networks and brands of many of the region’s most successful businesses. Contact Rod Young at rod.young@dcstrategy.com

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