A few months ago I suggested the use of financial modeling by franchisors
as a means for rational self governance of several critical aspects of the
franchise relationship, including measurement of the investment worthiness
of a franchise system and measurement of the extent to which a
contemplated program could be shown before the fact to impact upon
franchisee profitability.
Financial modeling isn’t anywhere near as valuable or available as a last
minute rush job slap dab project. It isn’t as credible when done that way.
It won’t stand up as well to cross examination. It is something that
improves over time through adjustments in the model to make it more
efficacious over a broader range of applications. It is not a one time
thing.
I recognize that most franchisors inherently fear financial modeling. The
reasons are many. If one franchise system’s model shows it to be
significantly less than the most profitable franchise system in its
business segment, who would want to buy a franchise in that system (once
it became known, and there are no secrets in franchising). To the extent
that financial modeling reliably depicts the financial performance of the
franchises in any given system, how can that information be used in the
context of earnings claims in Item 19 of the FDD? Conversely, would a
failure to use it in an earnings claim potentially represent a failure to
disclose significant pre investment information that any rational
franchise investor would want to know about in connection with making his
investment decision?
Franchisors also fear the operational implication of financial modeling
for the reason that it depicts the gravity of the impact of any franchisor
initiated agenda, and could be used as the basis for challenging the
agenda as a contract breach – destroying the legitimate economic
expectations of the opposite party to a contract without justification
other than greed. I will use the allegations by Quiznos franchisees to
demonstrate how financial modeling might be useful to their case had they
early on established an independent franchisee association that had the
resources to perform system wide financial modeling. As a caveat, I do not
know the extent to which their claims are true or will be competently
provable given that they have not consistently conducted financial
modeling over the history of the challenged franchisor behavior.
It is the position of the Quiznos franchisees, however, that Quiznos has
used the right to designate vendors for quality control and uniformity
purposes to extract an additional revenue stream from the franchisees that
is so large as to destroy any possibility of attaining a rational return
on any franchisee’s investment. According to the franchisees, they have to
pay a much higher price for supplies and ingredients than would be the
case in any competitive model that Quiznos franchises are tickets to
bankruptcy or at best only marginally survivable. There are other serious
complaints and other cases pending in the Quiznos system, but this is the
only one relevant to this article.
The first argument of those who don’t want financial modeling to occur in
franchising is that it is claimed to be impossible to prepare a competent
model because of differences in the treatment of categories of information
needed to populate the model.
My answer to that is that it is always the argument of someone who does
not want to do something. If financial modeling were deemed desirable by
the franchisor community, they would have done it competently long ago and
found that information can be harmonized competently through many
techniques that are responsible and that are used for financial analysis
across many industries.
The real reason why franchisors don’t want to do financial modeling is
simply fear – fear that if you aren’t shown to be the most profitable no
one will buy your franchises and your stock value will plummet. Even a
franchisor whose stock is not publicly traded lives with this fear. In any
sale of the franchisor, the reliability of its cash flow is a product of
its portfolio of enforceable franchise agreements. Franchisee association
financial modeling could represent a threat to its sale value, and
financial modeling by franchisees is something that simply cannot be
prohibited or prevented by any contract language. It is a legitimate
activity of any independent franchisee association and a franchisor cannot
by contract limit or constrain franchisees from engaging in legitimate
franchisee association activity. Moreover, franchisors must now identify
independent franchisee associations established by their franchisees in
their FDD documents.
It represents, therefore, an incredible potential weapon in the hands of a
competently run franchisee association for use in constraining franchisor
opportunism. Properly maintained, it is admissible forensic evidence to
show what must be shown to demonstrate that a franchisor has gone too far
and is actually violating its own contract by adopting programs that can
and probably will destroy the value of owning any of its franchises. This
is precisely the model that Quiznos franchisees claim in their litigation.
Had they been maintaining a competent continuum of financial modeling
throughout the period of the accused franchisor practice, their case might
be so good that they might not even have been compelled to sue to prevent
the harm.
A valid point often made by my friend Michael Webster is that independent
franchisee associations, especially when established early on and widely
supported, have enormous economic leverage. The leverage of such an
association can often trump the language of franchise agreements for the
reason that the franchisor knows he cannot really have a viable
organization if he is constantly in conflict with the franchisees, in the
mistaken belief that contract language trumps everything.
The value/leverage of a competent financial model of a given franchise
system is extreme. If you consider that any franchise investment is an
investment in a financial model, the ability and power to define that
model is the ability to drive the salability of the franchises. While
there is no such thing as an unmixed blessing, the inherent power of the
model owner/developer represents great power in the franchise relationship
itself.
My argument is that every franchise system’s membership should avail
themselves of an early on established, professionally managed independent
franchisee association; that the association should be universally
supported; that the association not only cannot be stopped but must also
be mentioned in the franchisor’s FDD; and that one of the indispensible
projects of the association is the establishment of an ongoing financial
model for its many beneficial applications.
It is something to which the association can turn when it is decided by
the membership that the use of the information in the model in responding
to pre investment due diligence inquiries of potential new franchisees is
the right thing to do. The association need not actually disclose to
potential franchisees what its model shows. It will be sufficient pre
investment warning for the association to contradict what the franchisor
may be telling prospective franchisees about the earnings potential of an
investment in its franchise. “Our franchise financial model disputes what
you have been told” should be enough to change any rational investors’
mind about buying a franchise. That is enormous power. Regardless of what
the franchisor is telling potential investors, sub cases in the model will
reveal whether the statements by the franchisor are responsible or
misleading. In the Quiznos model, that power could have prevented great
economic loss and possibly even a suicide or two.
It is a competent resource for the measurement of any franchisor initiated
program’s impact on the profitability of the franchisees’ businesses. As
such it can shift the burden of persuasion to the franchisor to support
its claims that the costs associated with any given program are likely to
produce incremental cash flow sufficient to justify the project. As things
are now, the franchisor says its programs are good for the system; the
franchisees have no data on which to challenge the claim; and the absence
of data allows the franchisor to show that the franchisees don’t know what
they are talking about. When nothing works and resort must be had to
dispute resolution, the forensic financial information needed to make the
franchisees’ case is already in place only if there has been competent
financial modeling as an ongoing association project. That data also
permits the formation of responsible decisions about whether there even is
a valid case to be made, as it will be the best available indicator of
potential resulting harm.
All the franchisee information that is to go into the model must be
anonymized. No one will participate who believes his privacy and the
confidentiality of his financial information will be lost. Aggregates are
reported in the model, not individual franchisee information. The
information to be provided by the franchisees will be provided to a third
party professional who will provide an acceptable reporting format. The
acceptability of the format will be worked out so that as many aberrations
as possible may be reconcilable/different treatments of line item
information will not produce skewed results. Line items will be treated in
a comparable fashion in the reporting protocols, regardless of how a
particular franchisee may treat the same information in his tax return.
That can be done in several ways, depending upon the nature of the line
item in question. No one will be able to trace the individual franchisee’s
information back to that individual franchisee. Of that I can be certain
and provide for in the agreement between the association and the
professional that is retained to build and maintain the model.
Ultimately, the ability to produce reliability in the model will be a
function of the franchisee associations’ membership support. It is mission
critical to this and to every other association function that it be joined
and supported by as close to all the franchisees in the system as
possible. To the extent that there are free rider non joiners, their
reticence will be accused by the franchisor as a reason why association
models should not be considered competent or reliable. Franchisees must be
inculcated with the belief that their participation in the association is
essential to their success and to their survival. While the approach
should be solicitous, there should also be sanctions for non joiners.
There is no free lunch, no free ride, and the association membership needs
to have and to enforce the discipline to deny assistance of any kind to
non joining franchisees. Yes, that is akin to shunning or banning. So
what? This is not a tea party. The accomplishment of independent
franchisee association goals requires universal participation and support.
People cannot be allowed to think or believe that they will participate in
the benefits of an association to which they do not subscribe. Being
deleted from association membership must be seen as so damaging to any
franchisee’s future prospects that none will dare fail to support it.
While no one likes confrontation, there must be reasonably effective
discipline amongst the rank and file for the association to succeed. That
discipline should begin with every new franchisee’s first coming into the
system. Every prospective franchisee considering the investment should,
immediately upon his first association contact, receive a very high impact
brochure about the value of belonging to the association and the impact
upon his prospects for success of his failure to participate. Association
membership needs to be part of the culture and the DNA of every franchise
system.
There is a lot of negative history in franchising. To be sure, there is a
lot of good history in franchising too. For many years people have been
looking for ways to counteract the draconian language used in franchise
agreements and the opportunistic and destructive behavior of some rogue
franchisors. The independent franchisee association is the best and most
effective way to accomplish that. |
