Icing on the cake
Tuesday, 7 October 2008
By Jason Gehrke
The process of granting franchises (or selling franchises as some refer to it) is one that can take anywhere from three months to three years. An initial inquiry from a prospective franchisee may not ultimately convert to a signed franchise agreement until an extensive process of assessment and reassessment has been completed by both parties.
Well, at least that’s how it should work in theory.
Sometimes the assessment stage is given scant attention by the franchisee, who is carried away by the emotional idea of becoming their own boss, and doesn’t fully examine what they are getting themselves into.
Alternatively, the franchisor can equally be too enthusiastic to complete a franchise sale in order to grow the network, replace an outgoing franchisee or for the cash injection a franchisee’s upfront payment provides.
To accelerate the rate at which franchises are granted (or sold), some networks use a strategy of offering incentives to encourage franchisees to move more quickly through their decision-making processes, reducing the overall acquisition timeframe and speeding network growth. Particularly in the current economic climate where access to credit is tightening, and potential franchisees are in short supply, recruitment incentives are likely to be used.
Tactics employed under this strategy may include the following:
Income guarantee
The franchisee is assured of a minimum turnover for a period after acquiring the business. This is effectively a way of underwriting a franchisee’s working capital requirements, and usually lasts only until such time as the business is expected to be sustainable in its own right.
However the income guarantee is often factored into the upfront fee the franchisee pays, so is rarely an impost on the franchisor. This tactic is more frequently used by service franchises, although the retail chain Kleins offered an income guarantee, which was later described by the company’s liquidators as one of the reasons for its demise.
Equipment upgrades or bonus stock
“Buy now” promotions that provide better equipment packages or more extensive stock inclusions at the same price can make a franchise more appealing. This tactic is similar to those used by motor vehicle manufactures with free accessories, extended warranties, fuel vouchers, etc. This tactic can be used by either service or retail franchisors.
Bonus territory
In the same vein as equipment upgrades or bonus stock, is the concept of bonus territory. What separates this from equipment and stock upgrades is the assumption that an increased territory will result in more income to the franchisee, and therefore a territory bonus is a good thing.
In reality, giving away bonus territory can backfire as an incentive because it can diminish the value of existing territories and undermine a franchisor’s territory planning methodology. It can also disadvantage a franchisee, who in a bid to service the entire territory may find that it is not economically viable to service far-flung customers. In order to be profitable, the franchisee may then withdraw to a “core” area and leave the bonus area unserviced, thus creating market gaps for competitors to exploit.
Vendor financing
With the growing fallout from the credit crunch and a tightening of bank lending, some franchisors are now offering vendor financing. The attraction for a franchisee is that a debt to someone with whom you are already in business may seem less onerous than a debt to a big bank.
If the franchisee has to provide real estate security (usually on the family home) for the debt, then the consequences of failure are equally severe whether vendor or bank financed.
However some systems may only take security over the business itself (including equipment, stock and debtors), and this may be an attractive offer depending on the other terms and conditions of the loan.
Buy-back guarantee
To give franchisees peace of mind in their business investment, franchisors may extend a guaranteed buy-back offer. While at first this would seem to remove risk from the franchisee, such guarantees are likely to be highly conditional, with the buy-back price generally determined by the written-down value of the assets of the business (and perhaps some provision for goodwill), rather than what the business actually owes the franchisee at that point. The difference between these two amounts can be substantial, and still leave a franchisee in debt if a buy-back is executed.
Price or fee discounting
Discounting the upfront price to buy the franchise, or offering honeymoon periods or discounts on ongoing royalties, are rare incentives, mainly because of their impacts on franchisor cashflow and the perception of value of the franchise offer.
It may work to a franchisee’s advantage, but potentially undermines the value of the franchisor’s brand, and detrimentally affect the resale value of existing franchisees’ businesses.
Last chance offer
Nothing motivates people to make a decision more than the prospect of having the opportunity to buy taken away from them. This is a sales tactic that has been used for centuries by salespeople selling any manner of goods or services.
Frequently, claims of “someone else is also looking at this, so you’d better decide now” lack any substance, and franchisees are simply being pressured to sign.
Fortunately the introduction of the Franchising Code of Conduct created an enforced delay in the sales process with the requirement to provide disclosure 14 days prior to the signing of a contract, and this delay takes the wind out of some (but not all) last chance offers.
If a potential franchisee is presented with a last chance offer that directly or indirectly pressures them into making anything less than a fully-considered and balanced decision, it is best to walk away from the offer altogether.
There are a number of other types of franchisee recruitment incentives used by franchisors to entice and acquire franchisees, and it is not uncommon to find more than one incentive being used simultaneously. Not all incentives are in the long-term best interests of the franchisee or the franchisor.
Franchisors should approach the use of recruitment incentives with caution to ensure that brand integrity, and the mutual profitability of both franchisee and franchisor is not compromised. Franchisees should equally be aware of the real cost of such incentives to their chances of future business success.
After all, nothing is a better incentive than a credible, leading brand, and happy and profitable franchisees.
Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.
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