You’re in it together. Franchisors’ concerns must be franchisees’ bottom lines.

By Stephen Hellner, CFE

Franchise concepts come in all shapes and sizes. Some grow and succeed, some start and just drag slowly on, while others get moving and then fizzle. Just as there are a variety of concepts in the franchising business model, there are also a variety of reasons behind their success or demise. One of the most critical factors in the success of a franchise system can be described as the “Franchisee vs. Franchisor Tug-of-War.” In other words: franchisors need to understand the issue, accept that there is an issue, deal with the issue, and plan for the issue if they expect to have a successful franchise system.

A Look at Top Line vs. Bottom Line

Seems simple, right? Franchisors and franchisees have two different perspectives as to what makes a franchise concept successful. Franchisors typically concentrate on the franchisees’ top line (revenue) and franchisees understandably focus on their bottom line (net profit).

Can the franchisor’s and franchisees’ interests ever meet?

Most franchisors earn a royalty stream which is generally a percentage of the franchisees’ sales. A franchisee can have significant sales volume with low profits; the result: franchisor happy, franchisee crying.  When franchisees feel this way, it’s most likely the result of a lack of teamwork between franchisors and franchisees. After all, we have always known that happy franchisees are the key to success for franchisors. For franchisors to grow a system to its maximum potential, they need to demonstrate, not just by words, that their first and foremost concern is the profitability of the franchisees.

This may seem to be common sense, but it’s easier said than done. Better communication has to start somewhere, consider these suggestions:

  1. Make royalty audits less scary. The word “audit” can intimidate franchisees; however, if franchisors find a way of developing a program which will improve franchisees’ profitability, the royalty analysis will benefit both the franchisee and franchisor. Franchisors often conduct royalty audits that are feared by franchisees.  However, “profitability enhancement reviews” can be conducted to determine if there are discrepancies in reporting, while also enhancing the franchisees’ financial reporting in order to improve franchisees’ profitability. 

The profitability enhancement process should be an experience whereby the franchisee is given hands-on, individual attention designed to provide suggestions to tighten up their operation; ultimately leading to increased profits. Common areas for improvement include suggesting cost-cutting strategies, restructuring labor, providing insight on ways to better manage the particular franchise, making recommendations for putting controls in place to prevent employee theft, and helping tighten-up service inefficiencies. Streamlining this process makes it less cumbersome for the franchisee.

2.  Comply with franchise Agreement Reporting Obligations. Complying with franchise agreements can be demanding as the franchisor typically requires the franchisee to submit certain financial reports on a quarterly or annual basis. The franchisor must use this information for the benefit of their franchisees. Franchisors should be supplying franchisees feedback based on their review of key performance indicators, such as average number of customers or average ticket amount for comparable locations, if applicable. Not only will the franchisor’s feedback help the franchisee, but the franchisee will appreciate that the franchisor is analyzing the franchisee’s financial information, and not merely just collecting data.

Other Franchise Agreement Legal Caveats

According to Lisa Biase, of the law offices of Lisa A. Biase, P.C., “it’s critical to resolve disputes in good faith. If a dispute between the parties becomes apparent, it would be well worth it for the franchisor to offer to host a meeting (or series of meetings) to help resolve the issue in person,” she stated, “Many states have laws which provide that all contracts are subject to an implied covenant of good faith and fair dealing. This imposes a higher standard upon the parties rather than what is actually written in the agreement. However, not all states have this standard and where it is lacking, franchisors should insert in their agreement a duty by both parties to resolve disputes in good faith (thereby making it a contractual obligation), even before mediation if that is an option under the agreement.”

Biase went on to say that a “personal meeting with the franchisee in an office environment — rather than a courtroom — will be less intimidating for the franchisee and thus foster an environment where true concerns may be openly discussed and resolved rather than briefed and advocated. A personal meeting will certainly be less costly than mediation, arbitration or litigation for both parties.” 

3.   Avoid surprises. Surprises for the franchisee typically are a reflection of poor planning on the part of the franchisor.

Franchisors that have an Item 19, Financial Performance Representation, in their franchise disclosure document, give their prospective franchisee a clearer picture of what to expect; but misleading the franchisees and a lack of transparency in the FPR misses the underlying purpose of the representation.

When preparing the FPR, the focus needs to be on what information is most helpful to the prospective franchisee as opposed to “what sheds the best light on the franchise concept.” Just showing total sales volume may be meaningless to a franchise operator.

4.  Understand your potential prospects when training franchisees

Identify innate skills. Franchisors should decide what basic skills are absolutely necessary for a successful franchisee to possess. Your search should begin with “who has the natural ability to be a franchisee.” Not everyone is meant to be a franchisee; therefore, the franchisor must determine which prospects have the basic qualities and skills necessary to be a franchisee in their system.

Determine skills that can be taught. The franchisee has been selected; the franchise agreement has been signed; now the franchisee has to be trained. The franchisor should focus on teaching the franchisee those additional skills that are needed to run the franchise. The franchisee will need to be a good operator; however, the franchisee may not need to possess every skill deemed necessary to run a successful franchise … and this is ok.

Know what to outsource, and when. For many franchisees, certain skills, although important to running a business, just seem tedious to franchisees that do not have the ability or passion to possess those skills. My suggestion: look into outsourcing those needs. For example, basic accounting and bookkeeping are essential for the running of a business. If a franchisee doesn’t grasp the bookkeeping concept or just does not enjoy working with numbers (although I can’t understand why they wouldn’t) the franchisor should facilitate the outsourcing of the accounting function.  Franchisors should make the franchisee work to their potential, but shouldn’t try to change the franchisee into something he is not.

Teamwork is the Answer

You’re in it together.  The franchisor’s concern must be their franchisees’ bottom line. The franchisees need to sense this through the franchisor’s actions, not by the franchisor’s promises. There needs to be a sense of urgency on the franchisor’s part in order to improve the franchisees’ business. Anytime a franchisor feels it can run the franchised location better than the existing franchisee, hands-on help from the franchisor, should be automatic. Franchisors need to convince the franchisee that changes need to be made so that the franchisee can operate a successful franchise. 

After all, in franchising, those who can do, teach!

Stephen Hellner, CPA, CFE, is senior director of the franchising accounting and consulting practice of Citrin Cooperman. Find him at fransocial.franchise.org

 

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