September 3, 2014
In 1998, a study performed by a graduate student at MIT’s Sloan School of Management found over 72% of the new franchise systems (i.e., franchise companies), in a statistically significant sample of franchises founded between 1981 and 1983, ceased to franchise by 1995. Notice, nearly three-fourths of new franchises failed within 12-14 years. Most new franchisors engage in policies problematic to their very survival. The aforementioned study found that, while age and size are relevant to consideration of whether a franchise is likely to succeed, “franchise systems … which are structured to economize on agency costs are more likely to survive than franchise systems which are not structured to economize on agency costs.”
What does it mean to be “structured to economize on agency costs”? Essentially, it means that the relationship between franchisor and franchisee is designed, ordered, and implemented in a way minimizes the costs of an agency relationship while maximizing the benefits of said agency relationship. How is that done? Primarily, franchise companies can be structured to economize on agency costs by creating, developing, and implementing proprietary systems and processes that achieve specific goals. The key to longevity is targeting the appropriate goals, and then creating & implementing the correct systems and processes to achieve those goals.
Of course, it goes without saying that all of this design & planning is useless without efficient, effective execution, but that is a better topic for a different article. To improve the probability of their survival, prospective franchisors should focus on six goals when creating and developing systems and processes to structure their franchise to economize on agency costs. That’s a mouthful. Let’s just summarize, Buzzfeed style:
6 Tips for Increasing the Likelihood of Franchise Survival
- Do not permit passive ownership of franchised outlets.
- Require relatively high levels of franchisee cash involvement (i.e., start-up cash investment).
- Establish and enforce industry experience requirements for prospective franchisees.
- At least at first, concentrate your operations in a relatively limited geographic area (e.g., one state or one clearly delineated region of the country).
- Keep it simple. Minimize the complexity of tasks for which franchisees will be responsible.
- Do not use master franchise agreements (contracts which grant the rights of development of the franchise to an individual whose purpose is to recruit, train, and oversee the operations of individual franchisees in an area).
What sets a franchise apart from an independent “mom & pop” shop is its standardized, scalable approach to operations. Economies of scale are only accessible to franchise companies structured to economize on agency costs. Hiring a franchising consultant could be a wise decision, if you are struggling to envision systems or processes franchisees can execute. Such consultants typically have experience taking your day-to-day operations and distilling them into processes and systems that can be replicated and executed by franchisees. This process is absolutely essential for a successful franchise company.
Be in the 28% of survivors. Follow the guidelines above, and, if necessary, consult a franchising consultant for additional help. One last word of caution: not all franchising consultants are created equal. Make sure you are hiring a seasoned professional with a proven track record of success. Be prepared to ask tough questions, obtain a list of verifiable references, and then follow-up on those references before hiring the consultant.
Finally, have your business attorney carefully review and suggest any necessary changes to the consultant’s contract for services. The right prior planning can make all the difference between being in the quarter of franchise companies that succeed and being part of the majority of failures in the franchising industry. Don’t cut corners. Build the right team, design the right systems, execute them efficiently and effectively, and prepare to reap prodigious rewards.
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