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Halftime Analysis: Where Does Franchising Stand in 2016?
1851 Franchise Talks with FRANdata CEO Darrell Johnson About the State of Franchising Entering Q3
When the franchise industry needs answers, they turn to Darrell Johnson, CEO of FRANdata. Over the company’s nearly three decade history, FRANdata has amassed an extensive knowledge base and Johnson has led the company for the last 15 years as one of the foremost experts on the ins-and-outs of the state of the industry. FRANdata works with more than 5,000 brands and more than 7,200 lenders and Johnson and his team have provided valuable analysis of the ebbs and flows of franchising for the International Franchise Association.
Johnson’s annual “State of the Franchise Industry” is highly anticipated every year, and as we close out Q2 and charge into Q3, 1851 Franchise decided to follow up with him to see things have shaken out so far since our discussion at the beginning of the year.
This is the first of two parts exploring the health of the franchise industry, what’s new at FRANdata, the trends, surprises, and projections for 2016, as well as the impact of the election season as we enter Q3.
We’re half way through 2016. How are things looking in the franchise industry?
The economic outlook is best described as “more of the same” from what we’ve experienced for the last year or two. It will be overshadowed by the political decision and all of the emotional reaction to that, but the economy itself looks like it will continue to grow at a slow pace. We’re expecting it to continue muddling along, Compared to the best recovery that I’ve ever seen, this one in contrast did not bounce back as quickly. I think that will carry into next year. Unfortunately we’re experiencing underperformance from an economic standpoint, but it does not become a recession or a negative performance unless we have a shock – which is possible but not likely.
As a research and advisory group to the franchising industry, we have a pulse on the concerns and hot buttons that face our constituents. We have seen an increase in interest in understanding franchise performance both from lenders looking to grow their franchise lending portfolio, to publications who want to know how best to highlight the fastest growing franchises. We also observed a growing interest for a number of foreign franchises to enter the United States. On the other side of the coin is the raised caution due to things brewing on the Hill in terms of joint employer and the minimum wage issue.
How is FRANdata doing so far?
We have the research and analysis advisory side, and then we have the capital access side. On the capital access side, the news is positive. Banks are aggressive now. They are stricter in their underwriting criteria for franchise brands because they’ve learned through the last downturn that franchise system performance, when properly understood, is a good predictor of future franchisee loan performance. That is allowing banks to be more flexible in borrower terms with the result that capital is flowing much more actively into franchising. We are very much centered on providing this objective credit risk service to the lending and the franchise industry. That part of the business is really an evolutionary change from where capital access has been historically.
On the analysis and advisory side, slow growth and rising uncertainty create a need for better due diligence and decision making advice – so that part of the business is growing too. If you don’t have a rapidly expanding economy, you need to be more efficient to get more of those revenue dollars to the bottom line. That drives the need for better information and analysis.
I am also excited about our soon-to-be expanded information/list capabilities which will allow franchisors to better understand demographic characteristics of their franchisees, knowing this will help them market to franchisees more efficiently. We have partnered with one of the largest sources of demographic data and foresee our industry analytics and franchise studies to become even more dynamic and nuanced than ever before.
For those who may not be familiar with your history, can you give me a quick run through on the history of FRANdata – and the evolution it has gone through to today?
FRANdata started as a regulatory document collection service in 1989. In the 90’s, it started using the documents it was collecting to become more of a data company. As the data became better understood, it migrated to an analysis company about 10 to 15 years in. From there it became a research company, understanding not just what its own data meant, but bringing in information from other sources and providing a research capability for franchisors and suppliers. It then became an advisory company – so not only could we collect, analyze, and research specific issues, but we now can help suppliers and franchisors understand what it all means in context of their business goals or dilemma.
It’s been a building block path – each stage built on the stage before it. We’re still a document company, a data company, and a research company. We’re now growing our advisory capabilities.
One of our strengths is on the business intelligence services side. For franchisors, it’s not only understanding where they are from a competitive standpoint and where they should be, but also a comparative standpoint of how they stack relative to their peers. Franchisors come to us and ask, “How do we start and go about it.” If they’re in the franchising business already, the question is more, “What should we anticipate next and what should do we build toward that expectation.” The advisory piece is built on top of the document collection and the research that we’ve done.
The other key business intelligence service vertical is the supplier side of the franchise community, who by and large are interested in targeted marketing. What is their value proposition for their producer or service, what type of brands make the most sense to target, and how do they go about penetrating that market? Those are questions we routinely address for them.
As noted previously the other half of the company is the capital access services. This service aims to increase and improve capital flow from lenders to the franchises. Each franchise system has a historical performance and a set of characteristics that either increase or decrease the likelihood that a lender will get their money back. We disentangle that and provide a service for the banking community to understand a franchise system’s credit risk profile. In doing so we also help franchisors to understand how they’re viewed by the banking community. This helps streamline franchise financing for franchisors and for lenders.
What are the major trends in lending today?
Banks build on the lessons of their past mistakes. When we were in the pre-recession period in 2004-2007, banks were under the impression that if it was a franchise, then the franchisee had a high likelihood of succeeding – so it started lowering lending standards, somewhat indiscriminately except for a few simple standards like requiring at least 25 or so franchised units. When we came through the recession, they looked back and found that there are better franchise system performers through a full economic cycle and weaker performers and just being a franchise doesn’t ensure success. They had to differentiate between brands that have characteristics that give them a higher or lower likelihood for success. They next found that SBA failure rate data were a poor proxy for franchise system credit risk. That led to the need and opportunity to produce standardized underwriting criteria for franchise systems and measure each brand against those standards.
Banks are going through their own expansion right now with more active small business lending. What they learned from the past is that there is a lot of information in a franchise system they need to understand to determine if they have a good shot at getting their money back and if that business has the right pieces in place. The lenders that are less active in franchising have only eased their way back into franchising recently. We have filled the credit risk information gap by continuously educating banks in how to understand and more efficiently analyze franchise loans.
In part two, we’ll explore the most powerful sectors within franchising so far in 2016, advice for new franchisors, and the impact this election season may have on the industry.
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