| Licensing, Technology Transfers, |
While there are certainly exceptions to any rule, one constant which I have observed is that the rate of franchisee turnover may vary directly with the sophistication of the franchise.
Sophistication of the franchise, in this context, refers to the intellectual and financial attributes of the target franchisee. Not surprisingly, this variance is from type of franchise to type of franchise, and from franchisee to franchisee within a single system. Certain profile descriptors apply for each kind of franchise offering. You don't sell a large initial investment, complicated franchise to a person with a high school education just because his father died and left him a lot of money. Or, to put it more bluntly, if you sell a franchise to anyone with the initial investment, you are really selling potential failure, not potential success. The person who will ultimately prosper from that transaction is your local litigator.
On the scale of sophistication, I begin with those offerings in which the franchisee could be said to actually be buying a job. These include gas stations, convenience stores, building maintenance, or drain cleaning. This is not intended to belittle menial franchise opportunities, but to point out that the lower you get on the scale of sophistication, the more you may need to expect to spend more money and time in governance and the higher you should expect your franchisee turnover to be.
This is of importance to the potential franchise buyer and to the potential franchisor. It affects the level of failure risk and the cost of administration of the system. Financial projections never factor in rate of turnover. It is near to impossible to do that in a forward looking mode unless you already have many years of operating history as a guide, but it can be done by comparing systems against each other. While I do not know of anyone ever doing this kind of analysis, it might be interesting to learn whether the net operating cash flow as a percentage of royalty revenue is a reliable evaluator of this kind of risk. I would limit the comparison to just the royalty income, because income from selling products and equipment to franchisees varies in ways that 'fuzz up' the numbers in this specific analytical exercise.
What, you ask, is this idiot talking about, and who cares? Well, the issue presents itself to me in several contexts. I have perhaps most frequently encountered the problems arising from this dynamic when a franchisor company decides to put on a big push to reach a milestone number of franchisees. The push to get to 500 or to 1,000 franchisees presents itself within the typical franchisor company in total and absolute focus upon reaching that quantitative goal. I have all too often seen qualitative considerations pushed into a drawer somewhere in the rush to be 'the biggest'. Frequently in this mode, a franchisor will sell a franchise to anyone with a check for the initial fee, and many lawsuits are sold in the belief that franchises are being sold. Accordingly, the more atypical an approved new franchisee is to the average successful franchisee in your system, the greater will be your future franchisee turnover rate, the greater will be your future legal costs, and the lower will be your future rationally expectable income.
If you were an underwriter or financial analyst, this exercise would help you more accurately evaluate a franchise company that has just achieved a large growth spurt, vis-à-vis whether to lend that company money, how much, at what rate of interest, and where to put the brakes on in the performance requirements stated in the loan agreement. To the best of my knowledge, no one has ever done this before. Obviously, this risk analysis would also apply to evaluating an IPO. I know that LSU has a franchising curriculum in its business school. Maybe this kind of analysis and research will be considered at that level if anyone wants to seek more reliable predictors of performance based on franchise sophistication profile analysis. To be sure, the manner in which you weight the dependent variables will affect the quality of the analysis, but that is a discussion for another forum. Remember, you heard it here first.
Part One of this article.
Copyright 1997 - 2008 || Richard A. Solomon
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