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There is a not so famous painting by Goya, hanging in the Prado Museum in Madrid, Spain, entitled Saturn Eating His Children, as horrible to look at as the title suggests. For several years I kept a small post-card sized impression of that picture on my desk, as I watched franchise companies without the insight to understand the need to diversify cannibalize their progeny financially. All this time I have preached that a franchising company either diversifies or consumes its revenue source through competing with it. (See How Full Is Your Monty, an earlier piece in this series). Now, thank God, within the last year or two, the message is beginning to get through. Several (less than a dozen) companies are actually starting to do that.
What eventually happens in any business is that one simply runs out of opportunities to continue to sell new franchises at the rate experienced in the growth phase of its life cycle. The initial franchise fee income that was enjoyed from new store sales during growth simply starts to dry up. My argument, that no one seemed ever to appreciate, was that the replacement of that initial fee income stream ought to come from finding another concept in its growth phase and franchising that new concept (or, better, those new concepts). It is an awful dynamic to attend marketing committee meetings and watch sales director after sales director be fired for not achieving a new franchise sales goal that has, by dint of normal life cycle history, become utterly unattainable. When a business becomes flooded with competition, such that price-cutting and other margin eroding promotions eat away at return on investment, fewer buyers are attracted. For reasons of quite similar dynamics, fish on the dock in the summertime tend to be priced lower in the late afternoon.
There's an English joke about a driver with his truck (lorry) stuck in a ditch, who hitches his pet cat to the front and flogs the cat to pull the truck out of the ditch. A passer by berates the driver for such folly, making the comment that it is unimaginable that one could think there is a possibility of the cat pulling the truck out of the ditch. The truck driver replies, 'I got this here whip, don't I!' The marketing committee meetings are much like that.
Unable to see that only so much blood can be squeezed from their turnip, the hell-no-we-won't-diversify franchising companies attempt to replace the lost initial fee revenue stream by going into competition with their franchisees. They get into Internet sales through a company web site. They take products that were once exclusive to their franchisees and start selling them in alternative channels of mass consumer marketing, including discount houses or grocery chain stores. What was once exclusive becomes a footballed commodity, and the franchisees watch the prices tumble and their customers shop elsewhere. It is a story I have dealt with so many times. All competently drafted franchise agreements today provide for the franchisor to invade what its franchisees thought for so many years was their somewhat private domain, because, instead of a fantastic business solution to an obvious problem, the decision is to get the damn lawyers to write a license to kill into the franchise agreement.
But now the new age is upon us, thanks be to God. Diversification's remedial potentialities are becoming recognized. What are some of the dynamics that will be encountered in this mode? Certainly, as the years go by, diversification will begin earlier, not at the point at which a franchising company is about to go over the hill. For now, however, it is occurring when franchisee ownership has substantially consolidated. The franchisor that used to have 1,000 franchisees owning 1,500 stores now has 100 franchisees owning 1,100 stores, plus a smattering of small franchisees essentially on their way out of the system. Franchise areas have been bought up, usually at bottom feeder prices, by people with the most actual operating experience in that business. With that arithmetic, consolidation investment becomes rational.
Ideas about how one treats franchisees in this mode could stand revisiting. It has been orthodox dogma that franchisees were put on earth to pay and obey. You were bigger, more experienced than they were, and you had this marvelous cat whipping franchise agreement bolstering your power to command, deus ex machina. Now, at this stage of the game, your consolidated franchisees are larger, much more experienced, can run the stores better than the franchisor can, have formed an aggressive franchisee association, and have hired a bloody dorsal finned lawyer with six rows of teeth to represent their interests. And they have very long memories. At this moment it could be that they are converted into supporters of their franchisor, or it could be the night of the long knives. How that contingency eventuates depends upon the franchisor's perception of what its franchisee corps now represents.
For one thing, they are not poor. They are in a position to invest in more businesses. The question is, will they invest again with you, or has that well of relationships been poisoned already? If you come up with another concept that could be sold and successfully operated in their geographic spheres of influence, they are potentially your best and most ready market. They have learned how to deal with you - but will they? They will be contacted for references by prospective purchasers of your new franchise concepts. What will they say about their investment history with you? Moreover, they can now make their statement to any potential franchisee anonymously. Instead of responding to any inquiry, not really knowing if it is bonafide or merely just an agent provocateur of the franchisor trying to 'get the goods' on them, they refer all callers to their association counsel. That counsel can inform any potential franchisee of the opinion of the association about what it might be like as the franchisee of your company. And, if s/he is good at what s/he does, you will never be able to trace the opinions to any particular franchisee(s).
What a tragedy to find that, now that the value of diversification is recognized, your best pool of marketing references has decided that it is pay back time.
The message of this article is that, as early as possible there is value in shedding the notion that contracts rule business relationships, even in franchising. Lawyers do not cure business issues by aggressive draftsmanship. Only you can preserve the into-the-future value of your franchise relationships. That preservation will come to you through getting on with diversification before you are sorely tempted to compete with your franchisees in order to replace initial fee revenue streams that have gone dry by dint of life cycle stage. Think of it as compassionate conservatism.
Copyright 1997 - 2008 || Richard A. Solomon
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