Throughout its history, franchising has shown an uncanny ability to stand the test of time, to prosper and grow even when the economy experiences a severe contraction. When the U.S. was reeling from the aftershock of 9/11, for example — when the economy was contracting by 1 percent and unemployment was rising to 6 percent during the next year — the franchising industry was growing, expanding by more than 18 percent in the five years following 9/11.
But in 2009, as the nation continues to suffer one of the greatest downturns since the Great Depression, the franchising industry has been hit hard. The International Franchise Association (IFA), the franchise industry’s leading trade association, just released its Franchise Business Economic Outlook for 2010, which found that the overall output of franchises declined by an estimated 0.7 percent – or $5.7 billion – in 2009. In the same time period, franchises reduced employment by 4.1 percent or 409,000 jobs. Such findings may just be numbers on paper, but the industry felt the impact directly as major companies suffered from unit closures. Quiznos closed more than 400 units between spring 2008 and spring 2009. Domino’s Pizza had to shut down 151.
Yet, from the rubble come signs of hope. In good times, Subway was one of the country’s fastest-growing franchises, and now, even in a difficult year, it continues to grow — adding 645 units in the last year alone. With a service that is needed in good times and bad, Liberty Tax Service added nearly 450 units in the past year.
Thanks to smart management and growth in emerging overseas markets, Subway and other franchises are prospering. But as access to capital and consumer spending continues to present problems (and will well into 2010), the shakeup in the industry is far from over. How franchisors respond to these and other challenges will determine which companies will be left standing once the dust finally settles.
The Lending Tree
As major banking giants such as CIT, Bank of America, and Wachovia have tightened up lending or exited the game altogether, access to capital has severely dried up — down approximately 40 percent this year alone, according to Darrell Johnson, president and CEO of FRANdata, an industry research company. Jeff Elgin, CEO of FranChoice, a network of franchise referral consultants, agrees: “Whether for new startups, existing business expansion, remodeling and upgrading, or simply working capital to run the business, loans are nonexistent. Our business is suffocating and barely hanging on because of a lack of credit.”
Unfortunately, the credit struggles are expected to continue in to 2010. According to a lending analysis report prepared for the IFA Educational Foundation by FRANdata and released in December 2009, banks are expected to lend $6.7 billion to franchises in 2010. This falls $3.4 billion short of the amount needed to meet 100 percent of demand.
The credit crunch is having an impact not only on the day-to-day operations of existing franchise companies, but also on the long-term outlook for the franchise industry’s growth. As potential franchisees can’t access the capital they need to buy franchises, franchise sales have slumped. To boost sales, an increasing number of franchisors are offering incentives just to attract investors, says Lorne Fisher, CEO of Fish Consulting, a national PR and marketing agency that specializes in franchises. These can range from deeply reducing — and sometimes even waiving — franchise fees and royalties to giving franchisees grand opening budgets and offering buy-back agreements in which the franchisor promises to buy back locations from dissatisfied franchisees.
Using such incentives to attract leads is largely unprecedented, and Fisher fears that while discounted fees could boost short-term growth, they may have a negative long-term impact. “By lowering these fees, it devalues the brand and the investment overall,” he says. “Also, the franchisees that did not get this [discount] can become frustrated and feel the franchisor does not value them.”
Other franchisors, such as Sylvan Learning, Edible Arrangements, and Firehouse Subs, are trying to combat sinking sales by acting as lenders, a difficult proposition in a tight credit market. While in-house financing programs are not new, they have been far from mainstream. IFA Chairwoman Dina Dwyer-Owens expects them to become more commonplace in the future. However, because franchisors have not traditionally played the role of bankers, Dwyer-Owens predicts that, even for experienced franchisors, the learning curve will be steep.
FRANdata CEO Johnson warns that franchisors will need to look closely at how lending programs and discounts will impact their own capital structures and be careful that they don’t get stretched too thin. On a larger scale, Johnson foresees a major shift in lending patterns as the concept of preferred lenders–established partnerships between franchisors and banking institutions–barrels toward extinction. Over the past decade, these relationships served as a major financial foundation for the industry. Lenders welcomed partnerships with franchisors, since they received a steady stream of new deals, and franchisors were happy because they could hand off all the capital concerns to another party.
The gap left by the exit of preferred lenders will be, in part, filled by franchisors’ lending programs as well as financing from community banks, smaller financial institutions, and private equity investors, but franchisors will have to work a lot harder and be much more proactive in helping to secure funding if they want to keep franchise sales on the rise.
The lending environment is changing the way franchises are financed, but there’s a whole other element that is altering the way franchisors do business. Social media has revolutionized how people interact and how information is processed. Facebook gives franchisors access to its 350 million active users; Twitter has grown 2,500 percent over the past year because of its infectious ability to transmit information instantaneously; and YouTube puts the power to reach a mass audience in anyone’s hands as 20 hours of video are uploaded to the site every minute.
For some franchisors, social media is an intimidating, daunting enigma that they can’t quite get their heads around. Others are recognizing that its power can be used to their advantage. “It’s a new tool in many toolboxes — sales, marketing, communication, advertising, human resources, and customer service,” says Gini Dietrich, CEO of public relations firm Arment Dietrich.
In light of today’s tough economy, how a franchisor responds to and uses this new medium takes on a new degree of importance. “Since the sale of new franchises may be lighter than usual in 2010, franchise executives will be looking for ways to increase sales at the unit level,” says Joel Libava, a franchise consultant and marketer. Many are already testing the waters and seeing favorable results.
When Toppers Pizza CEO Scott Gittrich announced on TV that anyone who correctly predicted the winner of the Packers versus Vikings game on the company’s Facebook fan page would receive a free personal pizza, Toppers’ Facebook network more than doubled in size, and all its franchise locations enjoyed a spike.
Through the rapid sharing and seamless processing of information, social media is keeping the franchising industry transparent, clean, and honest. When Sean Kelly, founder and publisher of a network of franchise-related websites, decided to blog about a franchisee complaint against Cuppy’s Coffee, it produced more than 300 comments from disgruntled franchisees. Nick Powills, CEO of No Limit Media Consulting, a franchise PR firm with expertise in social media, estimates that social media outlets will become the top venues by which franchisors obtain leads and potential franchisees research their franchise options.
Public relations expert Dietrich predicts that conferences will become obsolete as Twitter makes the exchange of information quick, free, and easy, and that trade shows will evolve into exclusive events where people can meet their online friends in real life.
Both Powills and Dietrich deem social media to be so important that they expect it to become an integral part of the Franchise Disclosure Document and franchise agreement. Powills foresees this happening as early as next March. To date, it’s unclear how social media concepts will be integrated into such formal documents, but it’s likely the documents will spell out what franchisees can and cannot do in the social media arena. It’s essential that such policies protect and control a franchisors’ brand in this new digital frontier. For instance, if some franchisees create their own individual Facebook fan page for their franchises, will the uniformity of the brand suffer?
Because social media is still relatively unexplored territory, some franchisors will inevitably fumble and have to learn the hard way. “There will be some uncomfortable experimentation, and maybe some disruption of the status quo, as franchisors explore how to harness the power of social media–and franchisees jump to its immediate use,” says Andrew A. Caffey, a leading franchise legal expert.
Survival of the Fittest
Thanks to the unprecedented economic downturn and the disruptive nature of social media, the franchising industry is becoming a present-day case study of a classic Darwinian theory. The industry has enjoyed years of growth and prosperity, but now that times are lean, franchising is undergoing a major shakeup that will sort franchises into two categories: the strong and the weak. “In 2010, we will see who the true leaders in franchising are,” predicts franchise consultant Fisher. “They will emerge stronger than their competitors and show that they have leveraged the recession to benefit their brand and company.”
Some of those players are already coming to light. Thanks to streamlined operations and offering the right products at the right time, Pizza Hut’s chicken-wings concept WingStreet, Subway, and Dunkin’ Donuts were among the fastest-growing restaurant franchises between spring 2008 and spring 2009, according to a 2009 survey conducted by The NPD Group, a provider of consumer and retail information for a wide range of industries.
Among those struggling most are Bennigans and TCBY, with Quiznos downsizing the most, with a total of 414 units closed. “Fast-food revenue and profits have been reported to be down anywhere between the 5 to 6 percent range,” says Ed Kushell, president of The Franchise Consulting Group, an industry consultancy. “This summer alone it was 3 percent and some have been as high as 10 percent.”
Finally, franchisors who are desperate to make their franchise sales numbers are starting to care less about whether candidates are really qualified and more about whether they are financially capable of purchasing the franchise. This could lead to a whole new wave of unit closures within the next couple of years. Warns Elgin at FranChoice, “Such actions will undoubtedly cause issues in the future that could have easily been avoided [had] franchisors not lowered their standards for new franchisees, even when recruiting got difficult, as it is right now.”
A Look at the Future
So what awaits the industry? The IFA predicts growth will be slow in 2010 as franchises struggle to overcome low consumer confidence, high unemployment, and restrictive credit markets. With these factors in mind, the IFA estimates that the number of franchise establishments will increase by 2 percent and employment by a mere 0.4 percent. Meanwhile, output is projected to increase by 2.8 percent – a sharp drop from the 9.7 percent average annual increase that the industry enjoyed from 2001 to 2005. Topping the IFA’s list of franchise categories expected to experience the largest percentage increase in economic output are personal services (4.4 percent), quick-service restaurants (3.2 percent), and businesses services (2.6 percent).
Mark Siebert, CEO of iFranchise Group, a management consulting firm specializing in franchising, predicts that because access to capital remains tight, lower-investment franchises will experience a boom over the next couple of years. To minimize the required investment and cut overhead, franchisors have already begun developing smaller satellite and express stores. For example, Cartridge World has developed a new store concept that enables franchisees to operate out of a 500-square-foot space instead of its traditional 1,200- to 1,600-square-foot locations.
In addition, franchisors will be forced to cut costs in order to compensate for meager revenues, and the introduction of new franchise concepts will slow down considerably as entrepreneurs realize that franchising is no longer a quick and simple way to expand and grow a business.
From here on out, a franchisor’s access to capital — and possibly even its chance for survival — will hinge on one simple element: performance. For franchisors seeking financing, performance will matter in a way that it never mattered before. According to FRANdata CEO Johnson, there will be more capital available in 2010, but franchisors seeking access to that money will be scrutinized by lending institutions and forced to demonstrate successful performance across three levels: unit performance, franchisor performance, and overall system performance. “We’re seeing the beginning of a dramatic shift in how franchise systems are assessed, evaluated, and compared,” Johnson says.
In the end, this shakeup can only benefit the franchising industry. Franchisors will be forced to provide adequate support to the franchisees in their system, a support that Kushell at The Franchise Consulting Group feels has often been lacking. Weak performers will be forced to perform better if they want to continue in the industry as active players. Strong performers will only get stronger. And quality, not quantity, will become the defining, measurable factor in a franchise’s success.
The franchising industry is in the process of evolving. The franchisors that are able to weather the recession, adapt to the new lending environment, and adopt social media tactics will become the key players in a whole new business environment. Those franchisors that show strong performance metrics at the unit and system level will have access to capital and thus the ability to grow and prosper. “I do believe that franchising will be considered the poster child of what small business represents,” says Johnson. “Not because it’s better or worse than an independent small business, but because it’s more definable, quantifiable, and measurable.”
See the full list of AllBusiness AllStar Franchises our editors selected as the best franchises for 2010.