The Sure Thing

“a good salesperson can sell around the disclosure document,” Levitt …

Report on Business magazine
December 1, 1998

The Sure Thing
Peter Thomas thought he’d bought into a can’t-miss franchise. That was $170,000 ago.
John Lorinc

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"I read the hype." says former franchisee Peter Thomas. "I just didn't realize it was hype."

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Since Michael Martino acquired the Canadian Mail Boxes Etd. licence a decade ago, revenues have hit $33 million.

On a cool September evening, 25 people gather at Mail Boxes Etc.’s Canadian head office in Oakville, Ont., for a “seminar” on the investment virtues of this San Diego, Calif.-based company that franchises store-front office-services outlets. Next to the seminar room, there’s a bright mockup of the now familiar red, white and blue MBE outlet, complete with photocopiers and postal boxes. The walls are festooned with promotional posters and a map showing MBE’s Canadian locations.

Franchise director Mario Sita is extolling the virtues of a system that taps into the “small-office/home-office market” and that offers prospective franchisees marketing support, training and financing through its approximately 4,000-location worldwide network. At one point, he quotes a statistic that he says was compiled in 1997 by the Canadian Franchise Association: While 65% of independent businesses go under in their first five years, only 5% of franchises fail. In fact, he notes, just two of MBE’s 200-plus Canadian franchises have had to close their doors. “Franchising will minimize your risk,” Sita says, reassuringly. Out in the audience, heads nod in approval. A few minutes later, MBE Canada president Michael Martino comes to the podium to field questions. “There’s one thing we try to subscribe to around here,” he says. “There are no secrets.”

There are two enduring truths about franchising: The first is that it tends to attract unsophisticated entrepreneurs; the second is that franchisors consistently go out of their way to convince prospective investors that they are buying into a sure thing, the favourite example being McDonald’s. The reality, however, is that franchising is at least as risky as going it alone, and can be more costly. And as Peter Thomas discovered, one of the great variables is location. Franchising, after all, isn’t exempt from the first commandment of retailing.

Tammy Turpin, manager of suburban Toronto MBE outlet, has no problem sharing the secret of her location’s success. Turpin, whose parents own three MBE stores, has Business Depot as a neighbour. Surprisingly, the office-products superstore serves as a magnet for Turpin’s business: While the retailer attracts small-business customers looking for supplies, it doesn’t do a good job providing services such as customized photocopying. She gets the spillover.

Bill Hossack, a former computer marketing executive, has owned another Toronto outlet for three years. His store is one of MBE’s first locations, an established fixture in a thriving mall in Don Mills. Still, it took him a year to turn the store around and get it to the point where he feels it should be. Now, Hossack says, the outlet does well, but not outstandingly.

Yet Turpin and Hossack know something that Mario Sita and Michael Martino don’t mention during their upbeat sales seminar: In spite of MBE’s low closure rate, not every franchise succeeds. Some outlets merely tread water, probably because they’re not located in the plum areas where small- and medium-sized businesses have mushroomed. Hossack and Turpin are both aware of the talk about turnover. But, Turpin adds, “A lot of the high turnover has to do with the attitude of the owners.”

Peter Thomas is a former franchisee tagged with the bad-attitude problem whose franchise was terminated in the spring of 1997. But the chemist, who lost his life savings during an unhappy 18-month stint with the chain, has a very different assessment of what went wrong, and why.

In 1995, after a quarter of a century in the pharmaceutical industry, Thomas decided to buy a franchise. He liked MBE because of its computer services and the fact that it wasn’t involved in the messy food industry. At the time, MBE told prospective franchisees that it had a 100% success rate in Canada: Since the chain opened its first outlet in 1990, not one store had closed. He put in an application. In October, 1995, Thomas anted up a $5,000, non-refundable deposit. “The words they used were, ‘Take a leap of faith,’” he recalls of his interview with MBE officials. And he did.

There followed a dizzying whirlwind of activity: Contracts were signed, locations scouted, training sessions attended, cheques cut. By January, he was ensconced in a brand-new MBE outlet on a busy suburban artery in North York, Ont. The small store shared a building with a pancake house. Almost immediately, Thomas noticed the parking spaces out front were always occupied by the restaurant’s patrons. Potential customers, Thomas contends, couldn’t approach his outlet because there was no place to leave their cars. So, from the word go, sales flatlined. “I had a lot of time on my hands,” he says. And that’s when Thomas started wondering how his fellow franchisees were doing.

The document that provoked his curiosity was MBE’s monthly sales memo, which ranks by revenue each outlet in the chain and contains the warning: “For internal use only…Do not disclose to prospective franchisees.” While Thomas’s store was always dead last in sales, he also calculated that between a third and half of the outlets were reporting revenues under what he considered to be the break-even point of about $13,000 per month. (In an interview, Martino says the break-even level is about $10,000, and points out that the company routinely tells franchisees that it will take at least two-and-a-half years for them to turn a profit.) Within six months, Thomas wanted out. But it took another year of stressful legal wrangling before he finally got his wish. Almost $170,000 poorer, he emerged from the franchise industry with a deeply cynical view of how companies like MBE attract investors with what he asserts are highly exaggerated promises. “I read the hype,” he says, pacing nervously around his living room, chain-smoking. “I didn’t realize it was hype.”

Hype is a big problem with franchising. Ontario is now pondering the tricky question of whether the franchise industry oversells itself by giving prospective investors sales pitches that cross the fine line between promotion and misinformation. The government is on the verge of tabling legislation requiring franchisors to provide prospectus-like disclosure documents to would-be franchisees at least 14 days before they sign a contract. While new to Ontario, this kind of investor-protection law has been in place in Alberta and much of the United States for years. No one is saying that government policy can discourage investors from making unwise decisions. But with disclosure, prospective franchisees, like investors playing the stock market, can have access to some reliable information about what they’re buying. And it’s also meant to discourage franchisors from making unsupported claims about things such as the store-level profitability.

At issue is an old and tenacious problem: Franchisors grow by selling new outlets for a fee of a few thousand dollars to $25,000 per outlet. The sales strategy hinges on the idea that consumers are attracted because of name recognition and familiarity. Implicit in this promise, however, is the suggestion that each franchise will perform similarly. In reality, however, the success of any given outlet depends on many diverse factors – location, the management ability of the franchisee, extra franchise-related cost and the willingness of the franchisor to oversaturate the area. In recent years, the growing expectation gap between the pitch and bottom line has helped fuel an alarming escalation in the number of franchisee-franchisor lawsuits – a situation that Ontario government hopes to remedy with disclosure legislation.

Unlike some of the coffee, pizza and doughnut chains, Mail Boxes, Etc., is not known as one of Ontario’s suspect franchisors. Together with a few other partners, Martino, a tough franchise lawyer, acquired the Canadian master licence about a decade ago. The company has expanded rapidly to more than 230 outlets, with system-wide revenues of about $33 million, or about $139,000 per store, in 1997. The parent company generates chain-wide revenues of $1.5 billion (U.S.), and is owned by the huge Washington, D.C.-based supplier, U.S. Office Products. Much of MBE’s recent expansion comes from a strategy focusing on profitable, high-end services such as colour copying, Internet access and desktop publishing.

Despite fast domestic growth (often a warning sign), MBE Canada doesn’t seem to position new outlets too close to existing ones, nor is it fighting lawsuits with any franchisees. (In the United States, MBE was served with a class-action suit brought by a group of disgruntled franchisees; the two sides settled out of court.) Conforming with Canadian Franchise Association (CFA) policy, MBE officials provide disclosure documents to would-be franchisees and don’t give out “pro forma” income statements based on concocted figures (a highly misleading sales gimmick still used by many franchisors). Nor are they absentee franchisors, as is the case with fly-by-night operators who do little more than collect fees from their unfortunate franchisees. In fact, the Canadian MBE operation is enough of a going concern that Martino and his partners last year acquired the master licences for the United Kingdom and the Republic of Ireland. “They’re financially strong,” says Don Mills franchisee Hosaack. “I think Martino’s running a good shop.”

But as Peter Thomas discovered, this doesn’t mean you can’t go broke with MBE. MBE sells hard to prospective investors. During that seminar in September, for instance, Sita told his audience that the average annual rate for same-store sales growth is 30% - a remarkable figure by any measure. Sita also said that the company plans to grow to as many as 600 to 700 locations in Canada, with system-wide revenues exceeding $100 million (Canadian) - a prediction that supports the idea that this is a company on the move. These remarks, of course, are merely forecasts. But they’re very effective. More troublingly, Sita also enticed his audience with the claim that just 5% of franchises fail, while 95% survive past the first five years. While he attributed this finding to the CFA, these numbers were actually put out by the U.S. government in the early 1970s and have long since been discredited by economists. Martino acknowledges the statistic is misleading: “To my knowledge,” he says, “we’ve discontinued using it.”

Another grey area is the reporting of the chain’s success rate. Until October, 1995, MBE claimed a 100% rate in Canada, pointing to the (then true) fact that no store had been closed. Since that time, the chain has shut two outlets and no longer makes this assertion. But this kind of information is somewhat masked. When Thomas lost his store, the new franchisee, who is the son of MBE Canada’s executive vice-president, acquired the assets, thus ensuring it would not close. (The franchisee’s company is registered at the same address as MBE’s head office.) Another franchisee, however, has yet to be found. Martino says it’s not uncommon to see a new owner revive the fortunes of a previously underperforming outlet. But this tactic guarantees that virtually every outlet remains open, reinforcing the notion that MBE’s track record is all but unblemished.

Franchise lawyers differ on the question of how effective disclosure legislation can be in terms of curbing such misleading sales practices. Ned Levitt, of Levitt, Beber in Toronto, says disclosure is the “cornerstone” of any franchise legislation. He notes that while “a good salesperson can sell around the disclosure document,” Levitt predicts that this kind of measure will persuade franchisors to be more careful with their promises. But John Sotos, a principal with Sotos, Karvanis and a scarred veteran of some highly fractious franchise wars, believes disclosure legislation alone will only “lull people into a false sense of security.” He, like other franchisee activists, believes Ontario should legislate further standards governing the relationship between franchisees and franchisors.

For his part, Martino favours disclosure legislation, and maintains that MBE did nothing untoward in its dealings with Thomas. He admits that a fast-growth chain will make mistakes in selecting franchisees. “There was nothing wrong with his site,” Martino says. “Peter just wasn’t right for the business.”

Thomas, however, isn’t buying that argument, mainly because he took the MBE sales line at face value back in 1995, when the chain’s success rate was still 100%. Like many naïve investors who lost their shirts in a tough industry that ‘s not nearly as safe as those perky sales presentations suggest, Thomas is bitter about his experience, and haunted by his lack of judgment. His 17-year marriage has been shaken and his health has faltered. He feels he may as well have gambled away all that money in Las Vegas. These days, he’s trying to sell his house in order to cobble together “a war chest” to finance a legal challenge. “When I went down the tubes, I thought it was myself,” he says with a sardonic smile. That’s when he started wondering about the true meaning of “success”.


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Risks: Disgruntled, Violence, Hates publicity, Legitimate Businessman’s Social Club, Necessary illusions, Mask of respectability, Blame the franchisee, Churning (serial reselling), Termination of franchisee, single, Canadian Franchise Association, CFA, Lawsuits, class, Broken relationships, ruined lives and alienated children, Cancer, Death, Veil of secrecy, Violence, Justice only for the rich, Happy serfs, Can’t talk to media, Success rate of 95 per cent, McDonald’s of…, Disclosure laws: False sense of security, Seminar selling, Disclosure laws: 10 per cent solution, General counsel, CFA, Dog and Pony show, Location chosen by franchisor, National press coverage, Canada, 19981201 The Sure

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