Six Tips for Franchisors Stuck in Mid-Trajectory
After surviving and thriving past the start-up phase, many owners of franchise businesses find their companies have suddenly hit a plateau. Franchisors stuck in “mid-trajectory” must adopt new practices and procedures to reach the next level of success. The irony is that the start-up stage is often considered the hardest part of growing a business. After years of work, franchisors feel that they’ve “made it.” A solid number of units have been established, and there is a steady stream of royalty income and advertising fees. Yet, there is a nagging frustration, a sense that as good as the business has become, it could be so much better. It may be doing well in its initial market, but the business is far from a household name with maximum market share. Additionally, there are other markets, here and abroad, that can be entered and conquered.
It’s important for franchisors to recognize that the company is no longer the same one it was when the business started, and some of the strategies that were adequate in the start-up phase will be inadequate, if not counterproductive, as the business moves forward. Included here are six tips for franchisors to reach the next level of success by providing the proper infrastructure for growth.
Take a Close Look at Franchisees
After selling to friends, family, former business associates, and others in their immediate network, franchisors start selling more broadly, to people they have never met. Going out into the broader market, it’s natural to have an eagerness to sell, to impress and to close the deal. Because of this, mistakes are made, and some of the sales go to people who should have been ruled out. Over time, the franchisor becomes better at selling and at weeding out those that wouldn’t be a good fit, and the quality of franchisees improves. But there will still be many from the early sales that need to be looked at closely. Some of them will need to be culled, and the business will actually shrink in the process. But the end result will be a stronger, more valuable group of franchisees from which to grow.
Take a Close Look at the Screening Process and Training Program
Step back and get a clear understanding of what makes a good franchisee. Being a successful franchisee may require technical ability (to reliably deliver whatever the product or service is), sales ability and business ability. Few potential franchisees will have all three qualities in abundance. This means a franchisor has to identify the core competencies that are essential for success in the franchise and screen for those.
In general, look for detail-oriented, high achievers—people who understand that closely following the store matrix will lead to success. A passion for customer service and quality control is a must for any service-oriented franchise. In addition to those qualities, each franchisee may need to have required technical skills, depending on your franchise concept, that are essential to its operations. The core competencies you screen for should be reinforced in your training program so that your franchisees remained focused on them.
Look Beyond the Top Line
When franchisors are in their early growth stage, they frequently use promotions and sales to build market share and a brand presence. That’s great for the top line and for royalty revenue. But wave after wave of discounts sharply cut into the franchisee’s bottom line—a strategy that will, in the long term, sour relations between the franchise and franchisees, if not drive them out of business.
Once a critical mass is reached, it’s time to re-examine the business’s promotions strategy. At this point, royalties are more than covering overhead, so view a less aggressive promotional strategy as plowing profits back into the business, creating a healthier bottom line for franchisees. Franchisees need to understand—and need to be shown—that their franchisor is on their side.
Get a Control Assessment
Besides ensuring that the franchisor is receiving the proper royalty payments and advertising contributions, assessing a franchisee’s financial picture can help spot performance trouble early on. Franchisors can then step in and work with the franchisee to remedy the problem.
Once a critical mass is reached, it’s time to re-examine the business’s promotions strategy.
An accurate picture of a franchisee is formed by identifying and getting the right information that takes the pulse of the franchise at key points in sales, purchasing, payroll and other processes. A steady stream of this information allows for construction of a “dashboard” that allows both franchisor and franchisee to monitor operations and performance.
Creating an accurate dashboard, however, can be a complex task. Once your business achieves critical mass, it’s a good idea to have a control assessment done by third-party experts. A control assessment looks at your current information flow and suggests the specific improvements necessary to ensure that the view you have of your franchise is thorough, timely and accurate.
Incidentally, don’t be surprised if the recommended changes are met with resistance from the franchisees, who are likely to view them as “Big Brother” intrusions on their autonomy. Counter objections by emphasizing how better information will help not just the franchisor’s top line but the franchisee’s bottom line as well. Enlist influential members of the franchisee advisory council to get buy-in—and feedback—from their peers.
Overhaul Your Defining Documents
Two defining documents stand at the center of any franchise business: The Franchise Disclosure Document or FDD, which governs the overall franchisor-franchisee relationship, and the store matrix, which acts as the day-to-day operations guide and benchmark for the franchisees. These documents should be revised continually, particularly in the early stages as you grow and learn. According to Lane Fisher, CFE, partner of of FisherZucker LLC, “Today, franchisors pay a lot of attention to the cost of establishing the franchise and the historical financial performance of existing franchises. Many of the 75 franchise systems that we represent devote substantial resources to reducing or value engineering the initial franchise investment in Item 7 and going far beyond gross sales to create a compelling financial performance representation in Item 19. Franchisors are increasingly presenting alternative measures of performance in their Item 19 FPRs like closing rates, average customer ticket, productivity of service vehicles, customer loyalty rates, etc. Many of these changes are made not only to assist the prospect, but also to educate the prospect’s lender, for whom the FDD is often the only source for information about your system.”
The only downside of these additions and revisions, though, are documents that may read like a quilt. It’s important to review the FDD and store matrix from start to finish and, at some point in time, rewrite them so that they speak with one consistent voice. In particular, go back over the numbers used in the store matrix and in the FDD Financial Performance section (Item 19). Use the wealth of empirical data now available to represent and benchmark the business that the franchise didn’t have when it was starting, allowing it to provide more accurate and robust estimates. Pay particular attention to how the advertising fund is set up—a decision which carries important tax consequences. For example, if the fund is carried as a regular business account, there may well be tax liability on unspent funds and the interest accrued. If, on the other hand, it was set up as a trust, overseen by a board on which the franchisees have representation, there may be little or no tax bill.
When the franchise was in its infancy, these nuances may have been glossed over in the face of the many tasks that needed to be done.
Scrutinize the Certified Financial Statement
It is critical that the certified financial statement—the final, authoritative statement of the business to your franchisees, franchisor, lenders and the government—and the rest of the FDD are in alignment. For example, the notes to a thorough financial statement will discuss trademarks your franchise may have licensed from others. If there are restrictions on the use of those trademarks by the franchise business or your franchisees, those restrictions must be accurately reflected in the appropriate section of the FDD.
As new agreements are made and old ones are amended, it is important to make sure that all changes are passed through to the various key documents.
A franchisor with a solid franchisee base and a steady stream of royalty fees has shown it has what it takes to succeed in a market crowded with competitors and ideas. Having passed those initial hurdles, the franchisor has earned the right to dream bigger, aim higher and seek to build a company that will stand as an industry leader. But doing so will require a new level of sophistication in processes and operations. A thorough review now can provide the infrastructure needed to continue that trajectory.
Aaron Chaitovsky, CPA, CFE, is the partner-in-charge of Citrin Cooperman’s Franchise Accounting & Consulting Division, which provides advisory services and financial, tax and control audits to franchisors and multi-unit franchisees in all industry sectors. Chaitovsky consults on many aspects of franchise financing, tax structures, acquisitions, royalty audit programs and succession planning. He can be reached at firstname.lastname@example.org.