By definition, an emotionally charged buyer is someone who makes a buying decision based on feeling rather than rationale and reality.  This creates fertile ground for a misalignment of expectations; the consequences of which are typically dire in franchising.  But why is franchising different?

Well, in scenarios where you may be selling goods and/or services and the buyer and seller are independent of each other once the transaction is complete the consequences are not as severe.

As an example, if I visit a car dealership and see a shiny, new, red, foreign sports car I might envision myself sitting behind the wheel, driving around, and being the center of attention.  It smells new, it looks new, and it handles great.  I could easily romanticize about all the joy this car will bring me, and it’s this type of emotion that will be easily picked up on and played by the car salesman.  Despite the high cost of ownership including the premium gas, insurance, expensive maintenance, not to mention the price tag – I can probably talk myself into buying it.  However, in a few weeks the newness will wear off and I’ll find that nobody was as impressed with it as I thought they would be.  I didn’t achieve all of the joy that I had envisioned that day while standing on the lot and now the reality of the gas, insurance, maintenance, and first loan payment has sunk in.  I still like my car but I can see that my expectations were not realistic due to my emotions.  I rushed the decision a bit, but perhaps I’ll sell it or just leave it in the garage.

The good news for the car dealer is that they aren’t relying on me to drive the car every day or to maintain it.  What I decide to do with the car after the sale is made has no impact on the dealer’s business.  A car dealer wants you to be an emotional buyer.  They want you to create an emotional bond with the car, fall in love with it, romanticize about how great it will be to have it.  Because a rational approach would require studying the total cost of ownership and being realistic about what you’re really getting and therefore you might not buy it.

In a franchising business model the seller (franchisor) is dependent on the buyer (franchisee) after the transaction.  This dependency creates a completely different relationship dynamic than a typical B2B or B2C transaction.  A franchisee who wants to sell their business soon after opening, or one who quickly becomes overwhelmed with the realities of operating a business and underwhelmed with the fruits of owning it is not an optimal situation.  If too many of these misaligned relationships occur during the growth phase of a franchisor’s life cycle the cost of unwinding them, in both financial and human resources, could easily drain the franchisor thus pulling the focus away from new opportunities and setting the sights on extinguishing fires.
The bottom line is that if your franchise sales process is primarily designed to create an emotional engagement with the candidate (especially those who have never owned/operated a business), without doing a thorough job of ensuring that expectations are aligned, then you are most likely setting the stage for long-term failure.  You will win the battle of selling franchises but lose the war of building a sustainable, healthy, franchise system.

Investing the time to create a sales process built around understanding your prospective franchisee’s expectations and criteria, instead of trying to create an emotionally charged buyer, is a step in the right direction toward longer-term success.

As always, I look forward to your feedback and comments.

1. Lack of consistent business processes in all areas including franchise sales, pre-opening, operations, and franchise administration.
2. Lack of IT infrastructure that enables the organization to manage their business processes.
3. Lack of analytics/reporting tools that enable management to benefit from business intelligence, or monitor and improve the business.

This is an excerpt from a typical conversation…

Us: “Can you briefly walk us through your franchise sales process.”

Franchise Exec: “Sure, we receive our leads through various portals or from our corporate website. The leads are emailed to a sales person (or our sales team) then entered into a spreadsheet.”

Us: “Ok, then what?”

Franchise Exec: “Then the salesperson follows up with the lead to see if they’re qualified and if so we send them an application to be completed.”

Us: “I see. What happens next?”

Franchise Exec: “If the application is returned, we review it to see if the prospect meets our initial requirements. If so, we send them a copy of the FDD, then we’ll invite them to our corporate office for a Discovery Day.”

Us: “What happens after the corporate office visit?”

Franchise Exec: “Well, we just follow up and answer any further questions; discuss the FDD; possibly refer a financing contact. You know, work on getting the agreement signed.”

Us: “Sounds easy enough. So, what’s the problem?”

This is where the conversation usually gets interesting and I say that for this reason – most folks begin to identify their symptoms, not their problems.

“We need to generate more leads.” Symptom.

“We are not meeting our goal for number of franchises awarded.” Symptom.

“We are not able to award franchises in the markets that we want.” Symptom.

“I don’t know what my sales team is doing on a daily basis.” Getting warmer, but still a Symptom.

Now, we could list symptoms for days. But the truth is that until the underlying problem is identified it cannot be solved. I would encourage you to begin working to identify the problems that are the root causes of your symptoms. Try starting with the problem breakdown that I listed above to see if this fits your organization.

As always, I would welcome your feedback.

“Even as some segments of the economy bounce back, the lagging pace of improvement in the real-estate market continues to hamper owners’ efforts at landing credit. “As the big guys are doing better, people ask, why not the smaller firms? Well, this is a huge part of the reason,” says William Dennis, Jr., a senior research fellow at the National Federation of Independent Business in Washington.

Because business owners used real estate to support financing endeavors in a variety of ways, the subprime crisis hit Main Street particularly hard as it rippled through the credit markets. Before the real-estate bubble burst, home and business properties were a reliable source of collateral for many businesses.”

Franchisors, who rely on and had relied upon easily available credit in the recent past for franchisees to expand, are going to have to reconsider their growth plans for the forseeable future as collateral values aren’t going up anytime soon. That is why it is critical for franchise systems to use this opportunity to sharpen their swords. Improving internal systems, methods and support to really help existing franchises achieve greater profit and stability is more important than ever. Franchise flywheel represents the type of tools ZOR’s should be adopting to put an emphasis on improving core capabilities until the damper on growth passes.

Franchising is tough right now. Its not just that lending has dried up for many franchise concepts. It isn’t just a function of the recent recession in general that is increasing economic pressures on franchises. The fundamental environment most companies face is becoming exceedingly difficult overall, requiring core changes to business concepts. These changes don’t just pertain to the franchise company itself but as importantly to the business models they promote and franchisees operate. Some key trends make it unclear wether many established and growing franchise systems are sustainable, as shocking as that sounds. The following four factors are providing most of the impetus for fundamental changes that franchise systems must make:

Increased competition
Advancements in technology;
Evolving consumer needs and wants; and
A more complex and demanding legal environment.

Increased competition

Competition is intensifying in many industries. An example is the fast food market where the most established franchise brands reside. As illustrated by tough competition in the U.S. pizza market, increased competition is resulting in flat to lower sales and discounting as companies attempt to protect or build market share. Ultimately this exercise is unproductive and will inevitably erode profit and sustainability.

Smart companies operating in highly competitive environments work hard to improve efficiencies and differentiate themselves. McDonald’s, for example, has been rapidly evolving its menu, operations, and offering of new services like wireless Internet access. The chain is also focusing more on quality to differentiate itself from others. But this is McDonald’s, the giant of the industry and a true exception. What will franchise systems a fraction of their size, which represents the clear majority of franchises today, be able to do ?

Curiously, more US franchisees have left the McDonald’s system in the past twelve months than in the previous five years. This is a telling trend and may be a clue for other franchise brands with lesser brand leverage and resources who attempt to respond to change. It just will not be an easy environment for franchise systems to navigate or survive.

Technology advancements

Advancements in technology is also increasingly impacting franchises. For example, the ubiquity of the Internet is radically shifting how smart competitors market their products or services. Conversely, the Internet has spawned new competition, like Amazon.com, which competes with traditional bricks and mortar operations. Other advancements, like inventory management systems, cloud based CRM systems, GPS devices and digital closed circuit television provide franchised operations with opportunities for improved efficiencies, security, and more sales. However, these tools also require effort and expertise for successful implementation throughout a franchise. They also require additional capital investments. Something many systems are incapable of or without.

Evolving Consumers & Legal Environment

Consumer needs are shifting rapidly posing a real problem for franchised operations. Coupled with the threat of lawsuits and legislation, an increased number of consumers watching their weight has resulted in radical changes to restaurant menus. As a result McDonald’s has introduced fruit, salads and wraps and Subway has introduced Kid Packs which substitute fruit for cookies and 100% juice for soft drinks.

There are obviously a number of trends and changes that must be considered by prospective and existing franchisors and franchisees. Some of these trends require quite fundamental changes to the way businesses operate. Navigating this change requires huge patience and resources to gain acceptance and implement. When applied to multiple business owners with limited resources and whom are dealing with great frustration this is quite problematic.

Bottom line is the SOP is not going to likely work for most franchise systems given the degree of change going on. If you are a manager, executive or franchisee, how aware are you of these pressures and do you concur with the analysis that your business models are feeling significant and greater pressures requiring fundamental change ?

At the Flywheel Group this has made us stop and think, given all the potential that the cloud offers clients particularly in franchising, that we need to do a better job of sharing more about what the “Cloud” really is.

Its really important for people in any organization to grasp the concept of the “Cloud” because it is going to touch everything in our lives and organizations, if it hasn’t already started to. Franchise executives and managers should take a moment to catch up on the basics with this quick video which is an excellent and short explanation of how Virtualization, Utility Computing and Software as a Service are converging to make Cloud Computing an important aspect of franchising today. Watch !

Unfortunately some organizations attempting to make significant changes in their information systems never realize their true potential. Often the “system” or technology is blamed as the reason. While there are flawed systems out there, they are rarely the key cause.

Putting aside the pros and cons of alternative IT solutions on the market, several barriers exist to realizing the opportunity information technology systems offer. A key one is the potential a system can deliver as opposed to what people actually do in their day to day functions. These two worlds are most often quite varied. The trick is understanding this gap and wisely designing an implementation plan that takes into account some important and practical considerations. This can be a painful and time consuming process, but failing to embark on the effort often leads to poor outcomes. The technology works great but goes unused.

People don’t like change, so no matter the opportunity change offers, it is rarely the technology and more often how people are included as part of a solution in tandem with a thoughtful plan that results in a system being more successful. Therefore, some key disciplines should be applied when implementing new information system technologies:

1. Identification of a single person in charge of the project;

2. Involvement of all user departments;

3. Documentation of extant business practice and process;

4. Documentation of the ideal process outcomes of a new system;

5. An assessment of staff skills as it pertains to the new technology;

6. Identification of specific steps required to shift from the extant practices to the new practices;

7. Identification of resources required for extra work and time involved in making the switch;

8. A training plan for staff to upgrade their technology skill and use of the new systems; and

9. Establishing a realistic time line with implementation phased in by appropriate functions.

Getting organizational buy-in is key. People need to understand what the opportunity is and feel they are part of its adoption. Also, having an implementation plan is crucial.  However, adhering to the nine disciplines above is difficult. Often businesses are going through change which heightens the need for improved business process that IT facilitates.  The solution is needed sooner than later and its common to let the details get “figured out later” when one has a general conception of how things might be, particularly when based on slick new potential that technologies offer.

To illustrate how important some of the nine disciplines are consider one: the documentation of extant business process and practice. If you are upgrading to a new system why should you be concerned about understanding the details of the existing system ? It is common for management to believe they understand present methods being employed in their own companies. After all they work there and often had a hand in designing processes. However, the devil is in the details, so while many an executive will tell you they know how existing processes are working today, many times they do not intimately understand them. Turnover, inattention to an area, or other factors may be the cause. Regardless of the reason, understanding how things are really being done is a critical first step in both identifying the greatest areas of opportunity but also in reducing the number of unanticipated gaps that may emerge in implementing a new solution. The painful reconciliation of the present to a glorious future is critical and people are often surprised at the outcome of the process. The discipline also serves to illustrate important aspects of a culture that may be impeding implementation; if an existing system is not working today because employees refuse to adopt tools or have not been trained, there will be a similar failure of adoption with any new system.

Another example of why the nine point are important can be demonstrated by contemplating this one: documentation of the ideal process outcomes of a new system. Specific outcomes are important to identify what the result should be. There is a difference between the general notion of an outcome and clear identification of exactly what will occur. It also important to know what exact requirements are part of the outcome. For example, if certain data or functions aren’t being performed reports won’t be generated. That wouldn’t be a failure of the system. It is often assumed the “system” alone is the solution; it is unfortunately not. The solution is a wise and integrated application of technology tools with an important understanding that people are its users. Just as a quality franchise concept can fail in the hands of a poorly oriented franchisee, so can a quality information system fail in the hands of an unthoughtful adopter. Achieving fantastic IT outcomes is as much about having a disciplined organization that understands its application and is using the tool. Again, the system is only a tool, it is not THE solution.

In closing, adoption of these 9 disciplines might require more time but is well worth the effort and critical to success. The next time you are considering the adoption of a new IT solution, keep these important points in mind.

Mrs. Fields Famous Brands recently warned that it will file Chapter 11 within the next two months if it cannot persuade note holders to cut $145 million in debt by the end of June. The Salt Lake City-based franchisor of both Mrs. Fields cookies and frozen yogurt retailer, TCBY, has an annual interest debt-load of over $200 million.

Another franchise brand consolidator, NexCen Brands, announced in 2008 that it managed to stave off immediate bankruptcy proceedings after an interest payment on a sizable loan came due. NexCen, a franchisor of Great American Cookie, Pretzel maker, The Athlete’s Foot, and others declared in May that it had discovered the sizable loan’s unfavorable terms and realized it had insufficient funds to pay it. Its CEO warned it faced a severe cash squeeze and had “substantial doubt” that the firm would remain in business. Recent interviews From November 2006 through January 2008 NexCen went on a shopping spree, buying nine brands in 14 months. In the end, NexCen choked after the acquisition of the Great American Cookie franchise chain, when the interest on its debt was so large that it placed the company on the edge of insolvency. The firm’s new chief executive officer, Ken Hall, and his team miraculously managed to turn the franchising conglomerate from a $38 million net loss in Q3 of 2008 to a $1 million net loss in Q3 of 2009 but the Company still faces significant challenges.

These aren’t the only brand “consolidation” plays feeling pressure as a number of firms remain in the hands of private equity: with no means to exit in the foreseeable future.

Ted Pearce, general counsel of Meineke Car Care Centers, wrote the following in a May 2008 Franchising World article titled Post-Purchase Synergies: They Come in All Types:

“As franchise markets began to mature and there were more and more similar franchise systems co-existing within a market, franchisors found ways to further leverage their ability to gain market share by co-branding with complementary brands to capture a market segment that the systems felt they were missing.  The present-day franchising world finds itself further consolidating under a common umbrella in an attempt to build efficiencies within a franchise concept and to realize synergies between these multiple systems.”

Efficiency is a great idea. Problem is most mergers don’t generate it. Here are some facts:

“70 percent of mergers fail to achieve their anticipated value…” – WEEKLY CORPORATE GROWTH REPORT

“Most mergers fail to add shareholder value-indeed, post-merger, two-thirds of the newly formed companies perform well below the industry average.” – HARVARD MANAGEMENT UPDATE

“A Towers Perrin study of 150 mergers of financial-services firms found that 30% of deals substantially eroded shareholder value, and another 20% eroded shareholder value somewhat…” – BEST’S REVIEW/PROPERTY-CASUALTY INSURANCE EDITION

“despite the well-publicized, much-analyzed fact that many of these mergers — up to 70%, according to some estimates — failed to create value, it seems clear that the end is not yet in sight.” – FINANCIAL EXECUTIVE

I was in franchise finance for a number of years and actually was involved in one of the earliest and largest merger acquisitions in food service history: Church’s and Popeye’s. I learned some valuable lessons first hand. While mergers might look good on paper, companies often fail to recognize the specific actions necessary to make two separate organizations behave like one. And the reasons for this are straightforward.

First, the people who focus on the acquisition are skilled in strategy, the industry and in finance. They have a very clear picture of the desired objectives of the acquisition, and understand how the new organization should return business efficiencies. But given the time demands of the pre-purchase activities, and their tendencies to focus on financial and business issues, the “people”  and “systems” issues don’t receive the attention they should.

Second, the idea behind an acquisition or merger is to create shareholder value; to grow the business. Bottom line is many of these transactions are cover for a franchise system that has inherent problems which management believes growth can solve. But it doesn’t. Clarity around processes, systems and people are not achieved through economies of scale. In fact the problems created by operating multiple brands often outweigh the benefits.

Third, people most affected by the merger, employees of the purchased organization, do not know the business objectives, see change as a threat, have no real influence over the events, and wonder immediately how they will be affected personally. Not surprisingly, the focus and priorities of the two groups are likely to diverge starkly.

The main reason why more than 70 percent of business combinations fail is inattention to the messy, detailed, nuts-and-bolts issues. If management truly had their hands around those details they might not need to acquire their way to success in the first place. Facts are that even “smart” “experienced” franchise brand managers are not as capable as they might think at dealing with the nuts-and-bolts. Having consulted with a variety of franchise executives, many whom have been touted in industry rags as being gurus, I can say that few possess deep understanding of their own franchise system let alone the ability to ascertain the workings of another they are thinking of acquiring. Therefore, to the extent consolidations continue as a strategy reflective of a maturing franchise marketplace, folks should remain highly skeptical of mergers as a means to realize efficiencies that create value.

Restrictions on available capital will reward those franchise systems that adopt intelligent management and systems which enable them to improve core operations so they are poised to rebound when the capital markets loosen up.

Here are four key trends that will continue to impede business finance for the foreseeable future:

1. Business credit will be scarce: Even as the banking system continues internal repairs in 2010, lenders will be reluctant to approve business loans, said Scott Shane, professor at Case Western Reserve University who follows corporate finance trends. The problem: Commercial real estate loans that have gone bad or are on the verge of doing so forced banks to divert money from capital accounts into loan loss reserves. Regulators are demanding banks improve their capital ratios, leaving them two options: Raise more capital from investors or reduce the book value, which means dropping loans.

2. Financing business start-ups will be nearly impossible: Start-up companies often seek bank loans to get going. When that fails, entrepreneurs use savings and personal credit lines for cash, or rely on friends and relatives for help. But Shane said going those routes is harder than ever. “People’s net worths have dropped, so they don’t have investment capital. Banks have cut home-equity and credit-card lines” to reduce their risk.

3. Selling businesses or taking them public will be difficult: Smart business developers think of an exit strategy from the day they launch a business. The possibility of big returns to investors via a sales helps to raise money. Typically, the strategy is either to sell the business or sell stock through an initial public offering. But opportunities will be limited this year. “Last year at this time, the IPO market was as bad as it has ever been,” said Shane. “I see only a handful of companies going public in 2010.” Jim Gilkeson, associate professor of finance at the UCF, predicts similar problems for those who want to sell businesses. The M&A market dropped over 21% last year, from 8,788 deals between January to November 2008 to 6,892 during the same period in 2009, said a Robert W. Braid & Co. report released in December.

4. The outlook for venture capital investment will remain poor: Venture capital fueled growth during the past decade, but investment plunged with the market crash of 2008 and has recovered only slightly since. According to the latest PricewaterhouseCoopers MoneyTree report, $4.8 billion in venture funds was invested nationwide in third-quarter 2009, up from $4.1 billion in second-quarter 2009. But that was down from $7.2 billion in third-quarter 2008. The Venture fund investments likely will be weak this year as funds remain cautious about the prospects for new businesses in a still-troubled economy, said Shane.

These sobering statistics only reinforce the need for franchise systems to focus on their core operations more intensely. The opportunity to re-engineer processes and improve operational and marketing systems is now. Those who use this time to get better at their core will be prepared to benefit from an uptick when financing becomes more available.

Why is this important ? By understanding the keys to success and applying certain disciplines from this learning, emerging franchise brands can greatly improve their chances of survival.

So what are the key variables that separate winners from losers in the franchise game ? Scott Shane of M.I.T.’s Sloan School of Management prepared some interesting academic research in 1998 which identified some key variables which are shown to be the key drivers of success. His research was published in Sloan’s Strategic Management Journal, Vol. 19, 697–707. and deserves close evaluation by franchise managers and franchisee participants.

The study tested his theories through the use of survival analysis on a cohort of 157 new franchisors established in the United States between 1981 and 1983 and tracked over time. The dependent variable in the study was exit from franchising; as previously mentioned Shane (1996) found that three-quarters of all new franchise systems ceased franchising within 10 years of their formation. The high rate of failure of new franchise systems suggested that survival of a new system over time is a critical measure of success (Carney and Gedajlovic, 1991).

Shane’s research focused on mechanisms that leverage “agency costs”, a financial theory which explains how best to organize relationships in which one party (the principal or franchisor) determines the work, which another party (the agent or franchisee) undertakes. Since the agent’s self-interest are in conflict with the principal’s, alignment of outcomes via contactual relationships is a key to mutual success.

Here are his key findings which set forth the underlying characteristics of successful franchise systems:

New franchise systems which permit passive ownership of franchised outlets are more likely to fail than are other new franchise systems.

New franchise systems which require higher levels of franchisee cash involvement are less likely to fail than are other new franchise systems.

New franchise systems which require franchisees to have experience are less likely to fail than are other new franchise systems.

New franchise systems which are geographically concentrated are less likely to fail than are other new franchise systems.

New franchise systems which are more complex are more likely to fail than are other new franchise systems.

New franchise systems which employ master franchising are more likely to fail than are other new franchise systems.

New franchise systems which have higher levels of total investment are more likely to fail than are other new franchise systems.

The results of the study indicate that franchise systems founded between 1981 and 1983, which are structured to economize on agency costs, are more likely to survive than franchise systems which are not structured to economize on agency costs. This finding is important because the failure rate of franchise systems is high, with over 72 percent of the new franchise systems in the sample ceasing to franchise by 1995.