Openness the key to franchise relationships in downturn: Zumbo

The vulnerability of franchise systems in the face of a deteriorating economy was highlighted during 2008 with the failure of three major franchisors. The tough economic conditions should serve as a timely reminder that franchising is not immune to economic downtowns nor is it a guarantee of business success. Both franchisors and franchisees can and do fail, leaving a trail of devastation behind.

In the past six months alone we have seen three franchise systems put into administration: Kleins, EzyDVD and Midas. Few businesses emerge unscathed from administration and franchising is no different.

With franchising, however, the consequences of a franchisor’s failure can be much worse. A failed franchisor inevitably leads to the failure of a large numbers of franchisees. That was certainly the experience with the Kleins collapse, and has been the case with other failed franchisors during the past 20 years. Barbara’s House and Garden, Cut Price Deli and Traveland are just a few prominent examples of where large numbers of franchisees have been left stranded or have also failed following the franchisor’s collapse.

As economic conditions tighten, more franchise systems will come under pressure or fail altogether. It is timely for all franchise systems to carefully assess their ability to weather the current financial crisis. Undercapitalised franchisors needing finance to survive or grow will be the hardest hit, as will those franchisors that relied on cheap credit to expand. These franchisors will have trouble servicing their debt.

Those franchises involved in retailing will also come under pressure as rents remain high while sales have softened. As shown by the Kleins collapse, franchisors who fail to respond to new competitors or changing consumer tastes will find it tough to survive.

Franchisors should also carefully review expansion plans in these difficult economic conditions. Aggressive expansion plans may be a recipe for disaster if the franchisor and franchisees are left exposed to declining consumer spending or the franchisor cuts corners on franchisee selection or training. Expansion plans should be carefully tailored to ensure that there is sufficient consumer demand to sustain the expansion and that only appropriate franchisees are recruited and given adequate training.

In these tough economic conditions potential franchisees need to look even more carefully at the franchisor’s financial viability. Potential franchisees should be asking to see the franchisor’s financial statements before signing the franchise agreement. A franchisor’s refusal to show a potential franchisee the most recent financial statements should sound very loud alarm bells. After all, a franchisor would not go into business with a financially shaky potential franchisee, so obviously a potential franchisee should not be going into business with a financially shaky franchisor.

Like anything in a successful franchising relationship, things should work both ways, with openness in dealings between franchisors and franchisees one of the hallmarks of a successful franchise system.

Frank Zumbo is an associate professor at the University of New South Wales.