Debate: 5 Reasons to be Skeptical of Franchises

On May 12, 2014, freelance reporter Eric Sherman authored a story for Inc.com titled, “5 Reasons to Be Skeptical of Franchises.” While I am not sure skeptical is the right word, considering data released by the U.S. Census Bureau in 2010 reported that franchises made up 10.5 percent of businesses across 295 industries in 2007, as well as accounted for $1.3 trillion in revenue and $153.7 billion in payroll disbursed to 7.9 million workers. Perhaps the story should have been titled, “5 Points to Research Before Buying a Franchise.” Regardless, Sherman’s article highlighted five warnings – all of which are accurate for any franchise prospect deciding whether to buy a franchise. However, in my opinion, fair reporting on any subject – good, bad, or ugly – should present both sides. The story should be unbiased and represent a full picture of the subject matter. After reading his piece, I felt compelled to share opposing views on each of the topics Sherman covered, so that anyone looking to buy a franchise wasn’t instantly repelled because of one opinion (while, clearly, Inc.com has a much wider reach/audience than 1851). Before I contrast my thoughts with Sherman’s, I do believe franchising should only be reserved for those who move past Sherman’s points. Far too often the wrong franchisees get connected with wrong brands. I also believe many brands that have become a franchise should have remained corporately operated. If consultants were a little more reserved on helping businesses franchise (or there was a more restricted process), franchising as a whole would be in a better place. His five warnings: 1) Beware the success claims. SHERMAN: “The biggest reason to embrace a franchise is that you supposedly have a higher chance of success. Except that you don't. A study from 2007 found that franchise restaurants fail at about the same rate as independent restaurants within the first three years of operation. Another study of Small Business Administration default rates showed that franchises defaulted at slightly higher numbers than nonfranchise businesses, although that appears to be a best-case scenario: The data may have underreported the franchise status, so the difference could be more marked. A study from the early 1990s actually found independent young businesses more likely to survive and more profitable than franchises. According to the International Franchise Association, the oft-quoted high survival rate numbers are incorrect. They were the results of 1980s studies from the U.S. Department of Commerce that have questionable relevance today. So, no, you aren't necessarily going to see a higher rate of success.” POWILLS: This is a tough one. Although statistics are facts, they only tell one part of the story. Sure, some data may point to franchise brands failing more often, but why? Franchises fail for two reasons: bad operations or bad operators. The sword has so many edges. An emerging franchisor typically needs franchise fees to invest more into the brand (sometimes to keep the lights on), and expectations are often out of whack. And the new franchisee may require more than two weeks of training to fine tune and then prepare for business ownership. People are ultimately the cause, though. People are brands – especially in franchise systems, where you have someone who has placed, in many cases, their life savings into that brand. Success claims are real though. Almost every franchise can point to success stories. Those are the franchisee profiles that prospective franchisees will want to duplicate – and should work hard to match. Franchisees pick the brand initially and franchisors let them into their systems. It is up to them to give it a full shot, invest in local-store marketing, follow the system, etc., to have a chance to succeed. Success ultimately rests on people. 2) The brand may not always benefit you. SHERMAN: “That can be true. It can also be false. When something goes wrong at one franchise location, it can hurt everyone else who owns one. Look at the cases of food poisoning at Taco Bell. Or the fast-food worker strikes that often effectively target major brands like McDonald's through the franchise owners. Being associated with a visible name isn't a guarantee of warm and fuzzy feelings. On the other hand, a small or new franchiser's name might mean nothing to most people, leaving you to do the heavy marketing work.” POWILLS: There are benefits, though, to affiliating with a known brand. A brand comes with great awareness. Think about all the great publications for which you write. If they didn’t have brand names, would people read or respect your writing as much? Brands are what you want to buy and be a part of building. If you were to write for 1851, your name would probably carry value, too, and we would rely on you to build an audience for your story. The challenge with an established franchisor is that you are less likely to have access to the territory you desire, whereas an emerging brand may offer you a top-tier city for development. Sure, you may have to spend more effort marketing, but you also get to reap the benefits of the great work you put into a brand. Brands will typically benefit you. Building brands together – that’s a major point of franchising. 3) Be wary of the operational numbers. SHERMAN: “A growing number of franchises seem to include aggregate operational numbers across all their franchisees in the financial disclosure document, or FDD, that all states require. That is good, because it gives you some grasp on reality, though don't take it at face value. Look at where the franchises largely are. If the franchiser wants to expand operations into your area and there aren't many representative locations, then the figures might be of little use. One multi-unit franchisee in San Francisco I've spoken with said that the construction, wage, and real estate figures for his area are much higher than what most other franchisees deal with. It's another good reason to call a large sampling of the franchise owners, and recent former owners, who must be listed. As for the franchise operations that don't want to pass on the operations data, why don't they? Is there something to hide?” POWILLS: I don’t think you should be wary of numbers or earnings claims – as they are highly audited and regulated. However, you should clearly understand the information that is being provided and what it means. When it comes to an earnings claim, the franchisor is showing a glimpse of averages, highest producers, labor costs – or whatever information they feel necessary to share with you so that they can answer the, “How much can I make?” question. These numbers are not guarantees. You don’t buy a franchise and make the $1 million that the top earning franchisees make. However, when looking at averages, you should plan to be much better than average. Why would you ever buy a franchise unless you thought you could be the best – or at least be in the top half of the brand? You should buy a franchise for the right reasons – certainly not to get rich quick. And certainly not so that you may say, “Well you said the average is X, and I am pissed that I am not making X.” The reality is, the responsibility to make money is on the franchisee. The franchisor shows you (and should provide you with) the tools to be successful. But it’s up to the franchisee to knock it outside the park. 4) Sole sources of goods and equipment can be expensive. SHERMAN: “There are franchisers that insist the franchisees buy all their goods, equipment, or stock from them. This is often a bad idea – Quiznos has faced lawsuits over the practice. Although some chains with imposed central buying do impose standards on the chain (go back to the bad brand reference) and can actually provide lower prices than local purchasing offers, there is always the danger that the temptation to create another revenue source from franchise owners becomes too great.” POWILLS: They sure can be expensive, but bulk purchasing can also lower the costs significantly. I had dinner with a food distributor a few weeks ago and we talked about the scale of a brand. He was saying that the purchasing power of a 50-unit brand could save hundreds of thousands of dollars for cheese in a pizza brand. Purchasing power is valuable. The other value is consistency of product. If you go to any McDonald’s, you should expect the same product no matter where it is consumed – whether you are a consumer or a franchisee. You bought a brand. You did not start Nick’s Hotdogs. Work together as a brand. There are certainly cases such as Quiznos, but in my opinion, that’s the wrong franchisee not really wanting to be a part of a franchise brand. 5) Some franchisers don’t care about your success. SHERMAN: “This is the biggest issue. Talk to enough former franchise owners and you'll run across those whose experiences of the central franchiser were less than positive. Perhaps there was too little guidance and assistance in vital areas like selecting the right real estate. Or maybe the franchiser was happy to sign up anyone who had the cash, even if someone had no experience in the industry and was likely to fail.” POWILLS: Wait, let me get this straight: Your point is for prospective franchisees to talk with “former franchise owners.” Right, because they will validate the franchisor. Come on. People are negative after they leave places on bad terms. It’s just the nature of people. How about they talk with great franchisees that have become multi-unit operators within a system they admire – such as Aziz Hashim. Talk with him about franchisors not caring. Even if the franchisor signs up anyone who has the cash, there is still the person who said they wanted it. It’s a two-way street. Nothing in franchising is guaranteed, but the notion that franchisors don’t care about their franchisees’ success is garbage. Of course they care. The more money the franchisee makes, the more money the brand is rewarded through royalties. Franchisors care. It’s just sometimes they don’t know the best practices when it comes to training, operations, marketing, etc. But it is up to you, the franchise prospect, to identify the x-factors, such as culture and fit, and make sure it’s a match – so that you can grow businesses together. When I happened into franchise communications after a career as a journalist, I was skeptical too. Then I had the pleasure of working with franchisees that were already in it. Sure, some of them really weren’t cut out for franchising. But that’s not completely the franchisor’s fault. People dream big. Some people dream about quitting their job and opening a franchise. Sometimes they go for it, and it just doesn’t work out. Would you be skeptical if I told you the one athlete I wanted on my team was someone who failed 9,000 times when taking a shot and missed 26 game-winning shots? Perhaps. But if I told you that failure was named Michael Jordan, you would take him, too. Failures happen in everything – including writing. The franchise industry has a tremendously positive impact on our economy – so there’s plenty of good. You should cross your T’s and dot your I’s with anything you buy – from cereal to cars to computers to houses to franchises. But, “skeptical” isn’t the right word. Perhaps “5 tips to be prepared for franchising,” or “5 tips to becoming a great franchisee,” or “5 tips to know you are not meant to be a franchisee” (like you want to change every process, as you are more of an entrepreneur than a franchisee). Any of those would have been a better tack to take, and produced a more balanced story.