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An Opportunity for Franchisors to Lead Their Systems Back to Economic Prosperity

By: Dennis L. Monroe

Krass Monroe, P.A.

Minneapolis, MN

I had a recent discussion with one of my colleagues, Barry Blum. Barry has a unique view of the current financing and economic issues of the franchise world because he has served as both an inside lawyer and business person and as a private practice lawyer representing franchisees and franchisors. We concluded there is a great sentiment weve heard attributed to a senior franchise executive that well paraphrase as Being a world-class franchisor is not about doing what you can, but its about doing what is right. We believe that when the prevailing economic turmoil is safely in the rear view mirror, many franchisors will be judged against that standard.

This means that todays unprecedented and difficult market environment presents a real opportunity for franchisors to distinguish themselves by delivering as world-class stewards of their brands and leaders of their franchise systems. That opportunity, of course, will be squandered by franchisors that choose to circle their own wagons, and fail to lead, or in some cases carry, their franchise systems through the present crisis. Such failures of leadership will destroy a number of systems, and will almost surely drive wedges between some franchisors and franchisees that will forever limit the potential of certain brands.

There are myriad ways that a franchisor will confront todays financial challenges and define itself in the eyes of its franchisees and the industry. The decisions a franchisor makes will need to be bold and measured, urgent and data-driven, and fair but case-specific. Over the next few years a franchisor that proves itself world-class, by doing what is right, will earn all the royalties it will ever be paid because its system will survive and emerge stronger than ever as the market improves and the future competitive landscape becomes clear.

Recently, weve helped several franchise systems understand better the present condition of their franchisees and helped them implement plans to address the challenges presented by the economic upheaval of the past 18 months. So, what are some of the areas that are ripe for franchisor leadership in the upcoming months and years?

Financial Distress

Many franchise systems will be faced with franchisees in financial difficulty, unable to service debt, pay royalties or advertising fees, or operate units profitably. Will a franchisor be proactive in anticipating issues, or will it wait to hear about problems from its franchisees? Will a franchisor be supportive of franchisees in financial distress due to market conditions, rather than poor performance or execution? At the same time, will the franchisor make appropriate, but often difficult, business decisions not to support every franchisee, and not let truly poor performing franchisees denigrate the brand by hiding behind the bad economy? These are some of the questions franchisors will need to address in the upcoming weeks, months and years. How many will devote enough resources to engineer solutions that fairly and adequately respond to the challenges franchisees are facing?

Development/Unit Count

Will a franchisor insist franchisees comply with aggressive development obligations that are impossible, or certainly foolish, to meet given the realities of the marketplace? Or, will a franchisor recognize that the lack of capital is real and acknowledge that adding a poor location is particularly foolhardy in this market? Will a franchisor adopt a policy of preserving unit count at all costs, or will it engage with franchisees in discussions about closing poor-performing units that threaten the franchisees overall portfolio. Will a franchisor step up to save unit count by acquiring units that franchisees cant operate profitably? Growth and unit count are always significant to franchisors. As the difficult business cycle deepens, franchisors will need to be sensitive to the costs and risks of growth for growths sake in this market.

Capital Investment

Will a franchisor evaluate for reasonableness and ROI existing or upcoming obligations to invest capital in facilities, equipment or initiatives? Or will the franchisor fall back on the franchise agreement that in fact obligates franchisees to invest capital on all things and in all amounts directed by the franchisor? This doesnt mean that investment must or can stop. Instead, investment needs to be measured by the impact on unit economics and profitability, and whether the investment will exhaust available capital and preclude more important investments. When capital investment is required, will a franchisor work to create and encourage sources of capital for franchisees? A franchisor can pitch lenders and investors, or assist franchisees in making those pitches. It can also use its balance sheet to create a flow of capital to its system for mission-critical initiatives. On the other hand, a franchisor can tell franchisees they are on their own, and a contract is a contract. This is an area where franchisors have a real measure of control over their franchisees financial commitments. It will be interesting to look back and see which systems navigate successfully through these troubled waters, and which ignore the storm clouds overhead.

Answering the Call

Now more than ever, franchisors will be judged on doing what is right, not what they can do under their franchise agreements. Of course, those two things are not always in opposition. Leadership may in fact be insisting on a plan that will be difficult to execute and has increased risk. However, the decision to go forward should be filtered through the lens of what is the right thing to do for the system, separate and apart from being something that can be mandated. What will your company or your franchisor do? The answer will have a real significant impact on the value of your business in the future. Here are some thoughts for franchisors on leading your franchise system through this unprecedented and challenging time:

Be Proactive Gather data, engage franchisees, and anticipate challenges.

Be Realistic Recognize the business and credit challenges confronting franchisees; understand that many franchisees have never operated in this type of environment.

Be Flexible Consider accommodations for development commitments or non-essential capital investment; acknowledge that survival might be the objective over the next several years.

Be Disciplined Dont allow truly poor performers to hide behind market conditions; some franchisees fail because they dont execute what is required to succeed; invest resources in a disciplined way by making informed decisions on who to support and how to support them.

In summary, a world class franchisor:

  1. Looks beyond the present downturn;
  2. Takes the necessary steps to build a stronger system in good and bad times;
  3. Uses the present downturn to build stronger relationships within its system; and
  4. Takes those necessary current steps to deal with the daily distress issues.