What's Wrong with Franchising?

…the franchising industry's image has been bruised by fractious relations with franchisees, who complain about poor support and onerous contracts that favor franchisers.

Business Week magazine
August 14, 2000

What's Wrong with Franchising?
The booming economy has scrambled this once surefire way to expand a business
Robert Deitz

It's easy to see why Ronald Escoffery wanted to franchise his Premier Learning Centers. The $1 million Atlanta day-care operation was thriving, and he envisioned a chain stretching from coast to coast, cloned without his having to come up with staff or capital himself. So in January, Escoffery, 55, a former banking executive and real estate broker, officially began offering franchises for Premier Learning. To reach that point, he had spent more than a year and over $150,000 in legal, marketing, printing, and other expenses to develop the document-known as an offering circular-that the Federal Trade Commission requires of all franchisers.

But to date, with the new school year fast approaching, Escoffery hasn't sold a single franchise, and he has missed the ideal season to open a new center this year. Out of 60 applicants, only three even met his minimum financial criteria.

As it turns out, Escoffery couldn't have picked a worse time to get started. Recruiting qualified, and willing, franchisees is harder these days than tracking down a good 99 cents hamburger. And quality counts. Escoffery knows that if his first franchisees fail, building an empire will be next to impossible. ''We're going to be selective,'' he says.

So what's the problem? Blame it on the prolonged strong economy, say franchising experts, which makes the concept less appealing to potential buyers. ''It's tougher today. When more people are employed, franchising suffers,'' explains Miami-based franchising consultant Chuck Woolweaver. Traditionally, franchisees have come largely from the ranks of the downsized. These days, those folks are more likely to find good jobs or start their own companies, leaving franchisers with fewer ready buyers. In an analysis of about 500 franchising systems in the 13 states that register franchisers, the number of new franchising units grew by 10% from 1996 to 1997 according to Frandata Corp., a Washington franchise-research firm. But as the economy boomed in 1997, franchising dropped off dramatically, growing less than half that pace the following year and only 5.4% from 1998 to 1999. ''It's gone up a little, but it's still very competitive trying to find franchisees,'' says Mark Vickerman, the company's director of research. The healthy economy also means that franchisees have other, more lucrative investment opportunities. ''Until April, you had the stock market going nuts for a while. So you also had people shifting money back to the market,'' says Jeffrey Kolton, CEO of Frandata and a franchising attorney.

Not that franchising is about to disappear. Franchises generate a staggering $1 trillion in annual sales—about half of all retail sales in the U.S. But it's a particularly tough time for new franchisers to get started. After all, there's room for only so many fast-food outlets, copy stores, and, yes, day-care centers. Fast food alone, which males up the largest category, had 219 systems competing for franchisees in 1998 in the 13 states that require registration, according to Frandata. Foreign competitors have also piled into the market, notes Sanjay S. Mehta, a franchising expert at Sam Houston State University in Huntsville, Tex.
They include Autobac's Seven Co. Ltd., a Japanese auto-service and supplies retailer, and MadScience Enterprises, a Canadian educational-systems provider.

On top of that, the franchising industry's image has been bruised by fractious relations with franchisees, who complain about poor support and onerous contracts that favor franchisers. ''The negative publicity has certainly not helped,'' says Susan P. Kezios, founder of the American Franchisee Assn., in Chicago which is lobbying for tougher federal regulatory oversight.

Finally, there's the Internet, a mixed blessing at best. The Net allows franchisers to recruit and screen applicants more easily, but it also subjects the franchisers to closer scrutiny. ''Franchisees are being more selective today,'' says Kolton. ''They're more sophisticated, and the Internet gives them access to information that wasn't available before.'' Potential franchisees can now scrutinize offering circulars at Franchise Planet (www.franchiseplanet.com), which lets them compare franchising fees and contract terms in the same industry. They can also contact, via the American Franchisee Assn., a small army of lawyers who specialize in representing franchisees (www.franchisee.org).

The shrinking pool of franchisees is hurting existing franchisers, too. Karen S. Marshall, president of Computertots, an international chain of 160 computer learning centers based in Great Falls, Va., is now adding about 10 centers per year, vs. 18 in 1996. To boost recruitment, Computertots started offering franchisees $2,000 bonuses last year for bringing in new recruits. So far, the effort has resulted in only one sale.

In short, it's a buyer's market. Still, some franchisers are finding ways to expand. What's needed? First, a strong business concept that's not just a fad. It must pick up on an enduring economic trend or a real need in the marketplace, says Frandata's Kolton. Then there's marketing. At Molly Maid, an Ann Arbor
(Mich.) cleaning service with 500 franchisees worldwide, the company has responded to better times by changing its tune. ''We've changed our marketing materials to appeal more to corporate executives who may not feel as threatened by corporate downsizing as they used to, but are looking for a family-friendly type of business that they can run,'' says Linda Burzynski, president of Molly Maid U.S. Meanwhile, Jim Ketchum, founder of Lubbock (Tex.)-based Christmas Decor, a business that designs and puts up outdoor holiday displays, pitches his franchises as a seasonal, supplemental income stream to roofers, irrigation specialists, swimming-pool contractors, and exterminators—people already working on commercial properties and private homes.

One of the newest recruitment strategies for franchisers is to take to the Web. It allows franchisers to qualify applicants in a matter of hours rather than days. Computertots, for example, has given up expensive print advertising. Instead, it places ads on franchising Web sites and recruits on its own Web site. The company encourages applicants to fill out an e-mail form with pertinent financial data.

The Web has also become a vehicle for a new and as-yet unproven breed of franchise: turnkey e-businesses designed to generate advertising or e-commerce revenue. For example, Wolf Schlagman, an ex-money manager for Dean Witter Reynolds Inc., is president of Miami-based MyCity.com, which offers franchisees the rights to operate a local community guide in their town. The cost: $27,500 a pop.

If all else fails, it wouldn't kill franchisers to be a little nicer about money and contracts. Robert Zarco, a franchisee lawyer with offices in Miami and Los Angeles, says none of the franchisers he knows have tried offering better financial terms, but maybe they should. Owners should make sure their contracts include a strong incentive for franchisees to grow the company, something Zarco says is absent from most deals. On other terms, such as dispute resolution and indemnity, sellers are starting to bend. Robin Day Glenn, an attorney for franchisers in Orange County, Calif., says she encourages her more enlightened small- and medium-size clients to leave out the draconian language, without sacrificing protection, and Kezios says some aren't enforcing one-sided clauses so zealously. ''Franchisers don't use the terms of the contract as the bludgeon they did before,'' Kezios says.

Will that attract more takers? Hard to say. But it's clear that both new and established franchisers are pinning their futures on an economic slowdown and, unlike most business owners, are actually cheered by rising interest rates. ''As corporations cut costs and cut personnel, that's going to help us,'' says Computertot's Marshall. Newcomer Escoffery is hopeful, too: ''Franchising is a long-term investment. We're going into it for the long haul.'' Some entrepreneurs, it seems, are determined to tough out the good times.

To learn about resources on the Web for both franchisers and franchisees, click Online Extras at smallbiz.businessweek.com

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