FRANCHISE HELL

How does the typical franchise work out? Rupert Barkoff, chairman of the American Bar Association's franchising committee, estimates that for the typical chain only a third of franchises do well, a third break even and a third are losing money.

Forbes magazine
February 1991

FRANCHISE HELL
Lots of successful managers, among others, think buying a franchise is the easiest way to financial independence. In many ways, it is the most difficult.
Richard L. Stern and Reed Abelson

AT 55, you're a successful and energetic manager and have had your fill of corporate bureaucratic life. You decide to retire early and buy a franchise. Perfect. You'll be your own boss, make a decent income, maybe bring the kids into the business and build it into something significant.

Now for a dose of franchise reality from Stephen Sherwood, former owner of six TCBY Enterprises, Inc. frozen yogurt stores around Kalamazoo, Mich. His stores were among the many forced out because of fierce competition in the yogurt business. Sherwood claims TCBY failed to respond to a changing market with a wider product line and wouldn't lower the price of the yogurt it sells to its franchisees in the face of cheaper and “better” product by competitors. “Franchising,” says Sherwood, sadly, “can be another form of servitude.”

Yet servants are lining up. Franchise trade show attendance is up by around 20% over the last two years. The International Franchise Association reports a nearly 10% increase last year in franchise outlets, sold by more than 3,000 franchisors. Highly confident of their entrepreneurial abilities, more than half of new franchisees now use the equity in their homes as collateral on loans to buy franchises.

How does the typical franchise work out? Rupert Barkoff, chairman of the American Bar Association's franchising committee, estimates that for the typical chain only a third of franchises do well, a third break even and a third are losing money. Meanwhile, the American Arbitration Association reports a 16% jump in disputes between franchisees and franchisors for 1990 over 1989 and a sixfold increase since 1980.

Ideally, the interests of franchisor and franchisee are one and the same: The better the franchisees do, the more revenue the parent organization makes. But business life rarely follows the ideal; the franchise business is rife with potential and real conflicts of interest. “The image of big, happy franchise families is nonsense,” says J. Michael Dady, an attorney who represents franchisees for the Minneapolis firm of Lindquist & Vennum.

The upfront fee from a new store is a big revenue and profit generator for franchisors. To close a deal, franchise salespeople (who mostly work on commission) sometimes yield to the temptation to exaggerate a franchise's potential. Employment agency franchisor Snelling & Snelling and video rental chain franchisor West Coast Video Enterprises have recently been accused of making inflated revenue and profit projections. The franchisors deny the allegations.

Another classic conflict comes about when franchisors boost their own profits but hurt franchisees by running promotional sales in which the store owner bears the expense for the lower prices. TCBY, which sells yogurt to its franchisees, recently offered a 99-cent Sundette, cutting big into store owner margins. Boosts in store traffic went right to the franchisor's bottom line because it sold more yogurt. And Burger King, which sells supplies directly to its stores, recently advertised a double whopper for 59 cents when you bought one for the normal $1.50. Bun and burger cost the franchise owner 53 cents. Add in overhead and the promotion was a moneyloser, says a franchisee.

Probably the most basic conflict between franchisee and franchisor centers on how many outlets there should be in a particular market. Theoretically, the franchisor cuts his own throat if he overpopulates a market with outlets. But it's hard to resist the money to be made by selling new franchises and expanding the flow of royalty income, even if the average outlet's revenues are imperiled.

Example: Almost 30% of publicly traded Blockbuster Entertaiment's $108 million pretax earnings in 1990 came from the over $100,000 it got from each of 277 new stores it opened, according to James Chanos, a money manager who is selling short the publicly traded stock. The company says only about 20% of its earnings come from new stores. This year Blockbuster plans to offer another 240 franchises, bringing the total number of stores to 1,026. Is Blockbuster overdeveloping its markets? The company doesn't think so, but Chanos does. He points to slowing growth in same-store sales. In the last quarter, Blockbuster's same-store average revenues crept up only 5%.

The best way a potential franchisee can protect himself or herself against overexpansion by the franchisor is to clearly delineate his territory's boundaries in his franchise agreement. But this is no guarantee. For many years Kentucky Fried Chicken granted its franchisees exclusive territories. But now the franchisor is canceling these exclusives as franchisee agreements come up for periodic renewal.

When a franchisor gets in trouble — as in the case of Al Copeland Enterprises, which runs Popeyes Famous Fried Chicken and Church's Fried Chicken — franchisees can suddenly find it hard to raise bank financing.

Still interested in pursuing financial independence by buying a franchise? Well and good. But do your due diligence. And don't forget this commonsense advice: Tastes change, and markets become oversaturated because they are easy to get into. If you buy a franchise and do well with it, there's no harm in selling out and moving on.

PHOTO: Del Blaske, 44, owns 22 franchised Burger King outlets in Minnesota. Last year he was diagnosed with a terminal liver disease and decided to sell out. Asking price: $14 million to $15 million. Burger King offered only $3.5 million. The banks refused to renew a line of credit, and Blaske says Burger King kept others from buying his stores. In January he filed for Chapter 11. Now he's suing. Burger King denies the allegations. (Layne Kennedy)

PHOTO: The Entre Computer franchise, with more than 150 franchised outlets operating nationwide, is owned by Intelligent Electronics (FORBES, June 10). Intelligent Electronics sees its future in computer superstores. “What will this do to my business?” wonders Brian Everhart, a Lakeland, Fla. franchisee who invested $65,000 in his Entre outlet. “Intelligent Electronics hasn't helped me in years. They don't need me anymore.” (Brian Smith)

PHOTO: Lelia Guilbert, of Torrance, Calif., joined a class-action suit against Diet Center Inc. after the franchisor was bought in a $160 million leveraged buyout in 1988. Guilbert alleges the new owners jacked up franchise fees, at a time of intense competition, to service their hefty debt. Four out of her five outlets — and hundreds of other Diet Center outlets — are now closed. The company rescinded the fee increase but also cut advertising. The new owners also threaten to take over closed franchises and resell them. Guilbert vows to fight on in court. (Elaine Isaacson)

PHOTO: Changing tastes and fierce competition in the frozen yogurt business have bankrupted many TCBY stores. Stephen Sherwood, whose six stores closed, blames TCBY for not introducing new products and for selling too many franchises. Though TCBY's earnings are collapsing, its chairman, Frank Hickingbotham, whose 38% of the company's stock is worth $66 million, last fall raised the dividend, increasing his dividend income by nearly $3 million a year. (Thomas Cinoman)


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Risks: Trade shows a major source of revenue for franchisor associations, Trade show are where the greatest lies are told, Must arbitrate disputes, cannot litigate, American Bar Association, Forum on Franchising, Protect gross negligence, wanton recklessness and intentional misconduct, 95 per cent of legal fees are paid by franchisors, Credence goods: taking advantage of the innocents, Symbiotic relationships (industry, banks, lawyers), Arbitration, secret, Arbitration firms have repeat business from franchisors, Arbitration is a private law that is much more influenced by money, Arbitration, mandatory and binding, Unfaithful servants, 1/3 franchises do well, 1/3 break even & 1/3 lose money, International Franchise Association, IFA, Renewal/refusal to renew, Lawsuits, group, Lawsuits, individual, Encroachment (too many outlets in area), Myth of Success, Cancer, National press coverage, United States, 19910201 Franchise Hell

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