Don’t Get Caught on the Wrong Side of This Odd Franchising Phenomenon

By temporary On Sep 3, 2022 77

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Parallax: the apparent displacement or the difference in apparent direction of an object as seen from two different points not on a straight line with the object.

Paradox: one (such as a person, situation, or action) having seemingly contradictory qualities.

— Merriam Webster Dictionary

The Franchise Parallax Paradox

One of the most interesting things about franchising is an odd phenomenon I’ll call the “franchise parallax paradox.” The same franchise is often simultaneously seen as a great business opportunity to some observers, while others have the exact opposite opinion.

Assuming that neither party has a personal interest in the answer (such as sales commission) and leaving aside questions of personal fit, often what separates these two disparate opinion-holders is their relative franchise experience. Their different vantage points create entirely different perceptions about the concept’s attractiveness as a business. They are also likely to have very different views about the long-term prospects for that franchise.

Information asymmetry sets up potential winners and losers. This economic truism also exists within franchising. For example, experienced franchise operators, franchise development professionals and consultants who are deeply entrenched in franchising, know which brands are headed in the right direction and which brands to avoid. This spills over into what brands you do and don’t want to see on resumes you receive for corporate franchise jobs. Private equity investors are also much better positioned to avoid bad concepts (or at least discount their offer price) compared to individual franchisee prospects without the same investing experience, industry connections and advisory resources. To improve outcomes, especially for first-time franchisees, the franchise sector overall needs to do a better job of using data to describe what a high-quality concept looks like.

High-quality franchises have common attributes and metrics that correctly identify them as high-quality — metrics over marketing spin. For example, strong franchisee validation scores as measured in franchisee surveys, coupled with a high number of license renewals and new expansion agreements signed by existing franchisees, is verifiable data that tends to signal a high-quality franchise. This data can be measured and tracked over time. Unit level profitability, high customer satisfaction scores and opening 100% of units sold are other examples.

The true markers of a high-quality franchise are data-based. But the franchise sector has, at times, developed amnesia about this. The relative merits of a particular franchise are chalked up to “fit” or mere differences in opinion, rather than being evidence-based. Sales puffery and overly aggressive marketing are overlooked with a caveat emptor industry shrug largely backed by a mountain of case law. This leads to a situation where the “haves,” with information about what a quality franchise actually looks like, will make one determination about a brand, while “have-nots” could be swayed by influencers, slick marketing, paid recommendations and unvetted lists. The very same brand can thus be viewed as a great opportunity or a dog, depending on who you ask and their understanding of franchise quality.

Investigating franchise concepts

As a prospective franchisee, be methodical in your investigation of franchise concepts, and involve as many people with franchise experience as you can. Network with reputable broker networks, franchise attorneys, franchising experts and franchisees themselves. Talk to competitors and get their impressions of any franchise concept you are considering. You need to know what all these people steeped in franchising know and also get as much data on the franchise concept itself as possible.

Also, look at the type of franchisees the concept attracts. Are all the franchisees first-time business owners? Do they have any background in franchising? Or do they tend to be more experienced operators? Groucho Marx once famously said that he didn’t want to be part of any club that would actually let him in. But in franchising, your potential franchisee peer group sends an important signal. Ask yourself, “Why is the franchise approving this particular type of candidate? Why is this type of candidate attracted to this business in the first place? Do I think they will be successful? If they fail, what is likely to be the reason? What did these franchisees know about franchising before selecting this concept?

Finally, has the brand attracted interest from private equity? It won’t be easy, but try to get a read on where any franchise you’re considering falls on the PE-interest spectrum. Is private equity actively rolling up multi-unit operators or brands? Have they acquired near competitors? Franchising continues to consolidate around platforms. If the brand you’re considering isn’t yet part of a platform but also hasn’t achieved scale on its own, try to find out what’s behind its decision to fly solo and stay small. If private equity already looked and took a pass, you may want to do the same.

A short case study perfectly (yet extremely) demonstrates the franchise parallax paradox: Burgerim. With a splashy U.S. market entrance and little actual operating history in its home country of Israel, Burgerim quickly sold more than 1,500 franchise licenses between 2016 and 2019. It only opened 200 locations before imploding and earning the company a rare Federal Trade Commission lawsuit.

For experienced restaurant operators and also some franchise analysts, industry reporters and private equity investors watching the story unfold, Burgerim’s fast franchise sales pace was a head-scratcher. First, the menu and operating model were complicated, but the franchise sales pitch was specifically targeted at inexperienced buyers. Consumer demand was largely unproven. Self-made comparisons to other wildly successful burger concepts, such as Five Guys, smacked of outright misappropriation given that the models were completely different, and Five Guys had an actual operating track record. Also, Five Guys attracted a strong base of experienced multi-unit restaurant operators that Burgerim did not.

According to FRANdata, there are approximately 775,000 franchise establishments in the U.S. alone. Approximately 50% are restaurants and food-related retail businesses. Restaurant operators also tend to be multi-unit operators. So, there were ample proven operators that could have been Burgerim franchise prospects. But according to Restaurant Business, Burgerim’s advertising instead specifically highlighted the low cost of entry and lack of experience required. “Facebook and Instagram franchise ads said NO EXPERIENCE NECESSARY in all caps and said people needed just $50,000 to open a restaurant.” This should be a huge red flag. But to the inexperienced, the story seemed attractive. Same brand. Two completely different perspectives based on both franchising and restaurant sector experience.

Also absent was private equity interest in the brand. A legitimately valuable and fast-growing franchise brand will normally attract private equity interest. But private equity was eerily silent as Burgerim continued to grab headlines with its fast license sales. Prospective franchisees themselves perhaps wouldn’t have picked up on this, but lenders, analysts and the industry press should have.

How to avoid the bad side of the franchise parallax paradox

Burgerim, of course, presents an extreme example. But there are franchise concepts being actively marketed right now that seasoned franchise observers might view as sleepy, risky, too expensive, unattractive or simply in need of more time to prove themselves. If you are a prospective franchisee, how can you avoid getting caught on the wrong side of the franchise parallax paradox? You need to close the knowledge gap by drawing upon the knowledge of as many insiders as possible.

First, create your own decision criteria based on provable data, not marketing hype. Make sure you are clear about your goals and how the franchise will help you achieve those goals. Put data against those specific goals. For example, “I need to make at least $125,000 per year owning these two units after repaying my initial investment in order to make this business venture worthwhile for me.” Okay, how many franchisees in that concept have actually achieved that? Involve reputable, experienced guides in your process, including a franchise attorney.

Second, get help — but be sure to ask anyone recommending franchises to you about their experience, training and compensation. Ask for references. There are experienced and well-trained advisors available with years of experience placing happy franchisees into good concepts. Hold out until you find a great advisor with a proven track record.

Third, network, network, network within franchising. Attend franchise conferences. Join the International Franchise Association, and learn about franchise best practices. Meet a range of people with franchise experience. Talk to competitors of any concept you are considering. Talk to franchisees. Would they do it again? Why?

You can and must close your franchise knowledge gap, but you have to be willing to put time and significant effort into due diligence. Help is out there if you ask for it. Experienced franchise operators and subject matter experts can help pressure test your assumptions and push you to ask the right questions. Vetted lists can help you uncover important selection criteria and questions you should be asking, but they are just the starting point.

Franchising is a proven model. But not all franchises are equally compelling businesses to run, much less the right fit for you. The most dangerous element in the franchise purchase process may be your own belief that you know more than you actually do. Be thorough and tap into franchising’s vast knowledge base, so that you can make a data-based decision like an insider.