The Dark Side of Franchises for Entrepreneurs

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The call of the wild is difficult to resist for entrepreneurs and would-be entrepreneurs. The wish for independence from the grind of working for another company and the routine of 9 to 5 employment is an insistent whisper which comes in quiet moments and isn’t easy to ignore. But stepping out and into your own business is a huge leap of faith, a risk, and we’ve all seen the empty commercial space left behind by those who were well-intentioned, yet unsuccessful.

In this situation, many entrepreneurs look at opportunities with Franchises or Authorized Dealerships. These opportunities promise some structure and, at a glance, seem to give direction and provide some comfort by reducing risk. As a franchised business, the business path has already been mapped out and tested by those who came before. The elements which don’t work for the majority have already been corrected. The ad copy on the Franchise page reads like a love poem, making many entrepreneurs swoon.

The upsides are often exactly what is pitched in the ad copy, and later communicated in meetings led by enthusiastic franchise company representatives. In many cases, nearly everything has a solution provided by the franchisor, from guidelines for hiring resources to point of sale software, and of course, product, marketing, and pricing. It would seem that all which needs to be done is to show up, and follow the plan. Smile, and think happy spring day thoughts of your future earnings.

With everything so well controlled, what could go wrong? Lots of things. I once had a car drive through one of my retail stores, stopping just short of the sales counter. The store was shut down for several months while the city decided, at their apparent leisure, whether or not the building was sound after the damage was repaired. In the interim, with no revenue, payroll still had to be made. Rent and utilities still had to be paid. But that was just bad luck, and of no fault created by the franchisor.

The tight structure of a franchise agreement or authorized dealer agreement can be both a blessing and a curse. The freedom of owning one’s own business suddenly doesn’t seem quite as liberated to those actually reading and understanding the fine print. Still, many agreements are signed, and many entrepreneurs do well with the structure, while some find themselves discovering that the risk is all on them, and that the arrangement itself creates new risk which would not exist as a truly independent business.

Franchisors control the vertical, and the horizontal. The cost of the product is usually determined by the franchisor. In most cases, the sales price of the product is also controlled by the franchisor. The margin is fixed, leaving the only opportunity for growing profits in growing sales. But the franchisor also, for the most part, controls the marketing message, and the promotions. If either or both of those fail to help grow the business, there could be trouble.

Franchisors have a company to run, and if the board makes a decision which benefits the company over the franchisees, the franchisees are along for the ride, chained by thick contracts and cumbersome commercial leases. There often isn’t any easy exit, and the franchise agreement often precludes any opportunity to build revenue in any other way besides the operation of the franchise within the leased space. If the promotions aren’t right for the market, and the margins are fixed, and there is no way to enhance revenue, there might not be enough profit to cover expenses. This happens in business, and the hope is that the good months will cover the bad months.

What you aren’t told as a franchisee, nor are the employees of the franchisor, is what is being planned behind closed doors. Are there merger talks, some sort of belt tightening? I was involved with a company once which was in merger talks with several other companies. At the dealer level, we had no idea what was going on other than the promotions had become much weaker, or even nonexistent, and the customers weren’t responding. Our local competitors were taking existing business from us quicker than we could replace those customers. We later learned of the merger and were told the company had gone into “cash conservation mode” while in talks. This had gone on for eighteen months and many of the dealers couldn’t carry the businesses for that long. For others, it was the beginning of a falling spiral which ended with a cloud of dust. Even after the merger, there were supply problems. Inventory became extremely difficult to procure, and we all know you can’t sell out of an empty cart.

Franchises can be a well-packaged solution, and successful in many cases. The dark side of franchises is the loss of control and the loss of profit opportunity which sometimes comes with the structure. Odds are that the franchisor will survive whatever decisions they make behind closed doors. They understand the options and can manage their cash accordingly. The odds for the entrepreneur who likely isn’t aware of what is being decided until well after the decisions have been made might be quite different. In the end, the risk which the entrepreneur had wished to minimize by pursuing a franchise might still remain, and some new risks become apparent.

Eric Huffman
Eric Huffman

Eric is a freelance writer licensed in Property, Casualty, and Life Insurance.

With over a decade of experience writing on insurance and finance topics, as well as need-based consulting, he brings real-world knowledge to these and other topics.

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