For franchisees and franchisors obtaining necessary capital is becoming an increasing challenge which is impeding growth. Unfortunately, finance experts think the ongoing cash crunch will continue to limit opportunities for some time.
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.
As this blog has reported before and as the flywheel group’s Clint Lee wrote in the white paper “Franchising, Disparity in Numbers”, a closer inspection of franchise industry promotional information about the great success of franchising is in order. All that glitters isn’t gold in franchising. While franchising can be a successful means of expanding a distribution system its reliability in achieving success is certainly questionable. This is particularly true for emerging franchisors. In fact academic research has shown that as many as three-quarters of all new franchise systems cease franchising within 10 years of formation (Shane 1996).
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.
“The significant problems we face cannot be solved at the same level of thinking we were at when we created them.” -Albert Einstein
In my previous post, titled “Designing a Process for Awarding Franchises – Part 1: Leadership”, I looked at the notion of how designing a process of awarding franchises has to start with prioritizing around the characteristics that your franchisees should have. Without fist hashing out this issue, it will be largely unproductive to tactically begin putting together a process that can be managed. For example, creating a system for “selling” franchises to individuals with no prior business ownership nor franchising experience is much different than creating a system of segmenting, targeting, and positioning your franchise to individuals and/or organizations who fit certain characteristics that you have pre-defined. Both of these philosophies will have different implications as to how you design your sales organization, generate leads, create opportunity staging, and develop appropriate metrics. Before you expend a lot of time, energy, and financial resources on becoming efficient make sure you are aligned for long-term success.
A Brief Look at Pre-Internet Franchise Sales
In the pre-internet days, back when times were simpler and your parents had to walk to school barefoot in the snow…uphill…both ways, sales organizations and marketing programs were designed a little bit differently within companies that franchised. Perhaps you would run some ads in the Wall Street Journal and other publications where you felt high net-worth and business-minded individuals would be reading, making sure to include your phone number very visibly -and wait by the phone. You could then hit the franchise trade show circuit, which is where these individuals might come to learn more, because really they had nowhere else to go since there was no internet nor websites to peruse. You would collect some business cards, get home and give a follow up call, send out a shiny hard-copy brochure – and wait by the phone. You might also implement a referral program whereby you would pay your franchisees for sending you leads that turned into franchisees. The franchisors who could afford it would perhaps recruit a seasoned franchise salesperson with an existing “rolodex” of contacts that they could call on.
Designing a process for effectively awarding franchises can be challenging. There is both a management and a leadership component to doing it. You may recall the image that Stephen Covey paints in “The 7 Habits of Highly Effective People” whereby a group of Workers are fighting their way through the jungle, wielding machetes and cutting through the underbrush while their Managers stand behind them “sharpening their machetes, writing policy and procedure manuals, holding muscle development programs, bringing in improved technologies and setting up working schedules and compensation programs for the machete wielders.” The Managers are helping the Workers to be more efficient.
The Leader, however, is the person who climbs the tallest tree, surveys the entire area, and yells, “Wrong Jungle!”
As Covey would say, management is efficiency in climbing the ladder; while leadership determines whether the ladder is leaning against the right wall. Peter Drucker says it this way, “Management is doing things right. Leadership is doing the right things.”
You’re probably thinking what does this have to do with awarding franchises, right? Well, the main point is that to design a truly effective process of awarding franchises you first have to be in the right jungle. The franchisor-franchisee relationship is a complex one that’s governed by lengthy contracts that spell out very specific obligations that each party has to the other. If certain expectations get misaligned or are altogether not addressed during the franchise sales process (which happens quite often) this will inevitably manifest itself and result in a problematic relationship at some point. If too many of these “problematic relationships” begin to present themselves this creates heavy baggage for a franchise organization and eats up much needed resources – both financial and human. Anyone who has first-hand experience with this knows that the costs associated with these problems can quickly consume any profit that was garnered through the franchise fee and subsequent royalty payments.
Bryan O’Rourke has written a very informative white paper that addresses this concept in more detail. You can get the paper here.
Let’s continue to look at the Leadership component of developing a process for awarding franchises.
As a follow up to yesterday’s post about effectively managing lead-flow, I’ve posted another video showing what I’ve found to be very useful and effective tools for lead generation. You might want to consider incorporating Google Adwords campaigns into your repertoire for franchise lead generation. The ability to target micro-channels and create highly relevant campaigns for specific target markets, along with the powerful analytical capabilities and budget options served up by Google Adwords makes it a no-brainer to incorporate into your overall strategy. The benefits of Adwords is exponentially increased if you incorporate it into your CRM system which will allow you to more easily analyze your ROI, among many other metrics.
Check out this video for an overview of the benefits of a Google Adwords and Salesforce mashup.
In the spirit of posting helpful information that has real-world applicability, I’ve put together a short video demo of effectively managing lead flow. This clip deals with managing incoming or reactive lead flow, as opposed to proactive lead generation.
Sophisticated franchise companies will have multiple lead generation campaigns in place, at all times, and in various mediums. The ability to integrate every lead, regardless of entry point, into your pipeline in real-time and rapidly route, contact, qualify, and follow up with these prospective customers (franchisees) would have at one time put you head and shoulders above your competition. Today, it’s a fundamental process that every organization needs to achieve long-term success. And it’s not enough to have a structured sales process in place. There should be quantifiable objectives and goals built into the process, along with the ability to track analytics at each step, so that a process of continuous improvement and a true reality can be seen in order to make the best decisions. The picture below is a good illustration of various entry points and a lead capture methodology.
I hope that this video will be helpful in learning a bit more about the way that we have worked with others to develop effective lead flow management processes and tools.
So much has changed around how franchise brands attract qualified prospects. Like many aspects of advertising, the game has fundamentally shifted. What can you do about it ? To be successful, brands must re-engineer their methods based on the following 9 disciplines:
1. Understand HOW and WHERE to engage qualified prospects;
2. People trust others more than brands, so franchisors need to mobilize their fans and followers to be cheerleaders. Consider this: franchisees are now the “creators” and “sharers” and “distributors”;
3. LISTEN: 3.5 billion brand conversations happen every day in the cloud and few pay any attention to them;
4. Franchise brands must be more honest and authentic: (a) only 5% of people say they believe ad claims, (b) half of consumers say brands don’t live up to promises and (c) franchisees are even more cynical, often for good reason;
5. Forget MASS anything; it’s ALL about customization;
6. Learn Digital or Die;
7. Measure as much as you can. Learn analytics and USE them;
8. Social media does not do everything; there needs to be integration with traditional vehicles of communication, but “pushing” tactics will not work. It’s now all about Inbound, i.e., customers and prospects pulling in a company’s message; and successful franchisors need to think more about communities than campaigns, learning to “crowd source”.
Successfully employing these strategies is hard for brands to do, primarily because they don’t have the tools to systematically perform these disciplines. Answers, however, are available. A quality solution that relies on the latest tools and trends can set a brand and organization apart, leading to true and lasting recruitment solutions that work.