Would Your Franchise System Pass the 'Stress Test'?

The current economic environment is making trading exceedingly uncertain and difficult for many franchise systems. But times were already challenging with, for example, changes in customer preferences, the market for supplies, the labour market and technology, and increased competitive intensity. All factors you’ll find in the strategy text book but might not have expected to conspire as they have. For examples of their impact, we need look no further than chains involved in video-rental, books, music & CDs, pizza and second-hand goods retail.

There are some franchise systems that are doing well, but many have been impacted. In fact, many have been hit very hard and there are some heart-breaking situations involving franchisees and franchisors alike. Now is certainly a time for franchisors to know their position in terms of strengths, weaknesses, opportunities and threats. Now is also a time to make plans that are realistic, and make the most out of available resources.

In the US, the Federal Reserve has taken steps to determine, rather publically, whether their largest banks are strong enough to cope with a sustained period of economic downturn - without requiring additional capital. To investigate this they tested the banks business models using two key outlook scenarios covering the economy, unemployment figures and house prices. The outcome was that 10 of the top 19 would require extra capital.

An important question for franchisors is should the concept of stress test be limited to banks, or would franchisors also benefit by engaging in a regular health check, benchmarking process and/or performance improvement regime?

For franchisors, it has become even more vital to consider how different futures might impact upon franchise system growth, development or even survival prospects. Proactive franchisors do this on a regular basis. Less active franchisors may wait until a banking covenant is already broken.

Looking forward, the reality is that we do not know the shape of recovery globally or in New Zealand. Will it be a V-shaped (probably not, because we would know by now)? Or will it be U, W or L shaped? Are we at the bottom yet, and how long will it take to get back to where we were? We are certainly all hopeful for economic growth in 2010 but the size, speed and shape of the recovery remains uncertain.

For some the current tough economic environment is exacerbating weaknesses that were already in inherent in the franchise system’s strategy, structure and associated management practices – or lack thereof. Accordingly, such systems are left more precarious as they may not have recognised [and built adequate reserves in] what we now regard as relatively good times, prior to the economic crisis which began unfolding in late 2007.

Weaknesses in franchise structure are crucial because regardless of business strategy poor structure can variously limit available opportunity, margin, efficiencies, and profits (and equitability) and therefore value. Importantly also, weaknesses in franchise structure often limit franchisors (and therefore franchisees) from implementing the types of initiatives and changes required to compete and build value effectively into the future.

The time has never been better for reviewing your overall franchise strategy, structure, practices and performance to identify what weaknesses and opportunities for improvement exist. The reasons for a review are several:

1. It is good practice. An independent review should really be undertaken on a 3 to 5 year cycle anyway to ensure you have the right approach going forward
    
2. Markets and other environmental factors change necessitating changes to business and franchise strategy and structure
    
3. Franchise system management knowledge, expertise and best practice is continually evolving, and/or
    
4. Some franchise systems were simply not created well, often times because the full range of franchise advisory specialists were not engaged at the time of franchising. As a consequence, many poor decisions have been made on aspects of franchise structure, and commonly structural aspects have been overlooked or forgotten.

So what should a comprehensive franchise structure review encompass? This depends on the situation. But broadly, the review must take into consideration the business model, franchisee and franchisor performance, and the franchise infrastructure. The franchise infrastructure encompasses many elements ranging from structural decisions, restrictions, protocols, processes and tools, and cultural elements contained within recruitment systems and documents, the franchise agreement, franchise manuals and training systems, franchisee support tools and programmes and the franchise support office.

All these areas must be considered within the context of the business and where it needs to head in order to compete most effectively and maximize value for both franchisor and franchisee stakeholders.