Franchising Risks: Identifying Them and Minimizing Them

Like any other business endeavor, franchising brings with it risks and benefits. Identifying the biggest franchising risks and trying to minimize them is likely to increase a franchisor’s chances of succeeding in his or her efforts.

One of the biggest hurdles in franchising is selling your first franchises. It is not enough to sell franchises to anybody. That would be too much of a gamble, and gambling happens to be among those franchising risks that have no place in a successful franchise company. You have to be certain that the franchisees you select will be the best possible fit for your franchise company. In other words, you have to vet them when they first apply to become franchisees.

 

Minimizing Specific Franchising Risks

 

If you have specific, detailed criteria describing your ideal franchisee, and if your criteria actually make sense for your business, then half the work is already done. You will be able to narrow down your pool of prospective franchisees so that it includes only the most desirable candidates. This is a very important part of the franchising process because, at the end of the day, it is the franchisees who will make or break your franchise company. If they don’t have the capacity to bring in a sustained stream of revenue then, sooner or later, you will be facing financial disaster.

There is no simple formula for selecting the right franchisee. Different franchise companies have different business models and offer different products or services to distinct markets. Selecting the right franchisee will necessitate attention to the unique qualities of your franchise company and calculations to determine what sort of person would be best placed to run a franchise unit in it. Simply duplicating the formulae followed by your competitors would be a big mistake. Business decisions must be tailored to suit specific businesses. Applying generic solutions to specific problems in such a scenario would be one of the biggest franchising risks you could take. Chances are you would end up experiencing problems in your relationships with your franchisees.

Other franchising risks become relevant during the later stages of the franchising process. One of them is the risk that franchisors take when they push for the accelerated growth of their franchise companies too soon. Such franchisors forget that it is their role to nurture the already operational franchise units and ensure they are thriving before running off to sell thousands more franchise units. A franchise company is viable as long as it has the capacity to give support to its established units. If a franchisor sells too many franchises too soon, then his or her resources will be stretched too thin. It will not be possible to give all the established franchisees the services that are provided for in their respective contracts. Naturally, without this kind of support and investment, the franchises will not do too well. This will ultimately result in the drying up of the franchisor’s revenue stream.

Franchising Guide

In order to turn your business into a franchise company, you need to have a set of recommendations to follow: you need a franchising guide. It doesn’t have to be a single, comprehensive text offering you every bit of information you need to know about franchising. Your franchising guide could be a website, or a series of websites designed with prospective franchisors in mind. It could include useful articles about the franchising process as well as products for prospective franchisors to purchase.

Websites of this kind are often directed at individuals who would like to be directly involved in the process of franchising their businesses. They may have reservations about simply handing the whole process over to a franchising expert or consultant without themselves taking the time to understand what it entails. Thus, they visit these websites, seeking to understand the steps involved in franchising, and the resources necessary to execute them.

They may ultimately decide to go the do-it-yourself route as franchisors. Alternatively, they may decide to hire professionals to facilitate the entire process for them. If they opt for the latter, they cannot be said to have wasted their time looking into the process and then handing it over to another individual. In fact, their actions are commendable. By seeking to first learn what they can from an online franchising guide, they are better able to supervise the franchising of their businesses by experts. This is positive. After all, informed ‘bosses’ are far more effective than ignorant ones.

 

A More In-Depth Consideration of the Franchising Guide

 

Some of the topics that an online franchising guide is likely to tackle include tips for identifying a business that is suitable for franchising, the pros and cons of franchising one’s business, advice for selecting the best possible franchisees from a pool of applicants, recommendations for optimizing a franchise agreement, and the legal issues faced by franchisors.

In some cases, franchising guides are not websites, but magazines and other publications from organizations that focus on franchising. Such associations include the International Franchise Association, and regional organizations like the ATLFA (Atlanta Franchise Alliance).

Among the best resources available to prospective franchisors are actual franchisors who have been doing it for years and can talk about it, not in general terms, but with reference to specific contextual details. Information of this kind is critical in helping prospective franchisors understand the complexities involved in the franchising endeavor. Reaching these franchisors need not be an impossible mission. Thanks to social networking sites, there are plenty of opportunities for aspiring franchisors to ‘meet’ ongoing franchisors and to learn from their mistakes and their successes.

Franchise Territory

A franchise territory is a region within which a franchisee has the right to locate his or her franchise unit. You could call it the catchment area for a particular franchise unit’s customers. If the franchise territory is exclusive, only one franchise unit of a given franchise system will be located within it. From a franchisee’s standpoint, this is ideal as it means that there will be no competing franchise units to contend with. From your standpoint as a franchisor, it may or may not be ideal, depending on the nature of your franchise business and other factors.

As a franchisor, you earn most revenue when the franchise units in your franchise system profit. So it is in your best interest to see these units thrive. If you allot each franchise unit a disproportionately large franchise territory, you will have more potential customers than you can serve. Chances are that you will end up losing them to competing businesses. This is not ideal. On the other hand, if you allot each franchise unit a disproportionately small territory, or if you allow more than one franchisee to set up franchise units in one territory, you could easily end up undermining all of the franchise units. They may find themselves competing for a limited number of customers. Sooner or later, at least one of them will go under because it will be impossible to drum up enough sales or profits to continue running.

 

Facing the Franchise Territory Issue Head On

 

In order to avoid future disagreements with your franchisees over franchise territory, you must make sure that this issue is addressed in length and in breadth in the franchise documents (i.e. the franchise disclosure document and the franchise agreement). Most importantly the conversations on the subject should take place before any documents are signed or transactions between you and your prospective franchisees completed. Hashing out details of this kind beforehand is the best way to ensure that franchising is as smooth a process as possible.

There are a number of details you should clarify in your conversations with your franchisees about territories. You should indicate to them what the nature of the territories will be (i.e. exclusive, non-exclusive or non-existent). You should also clarify what the process of determining territories will be. If you reserve the right to determine the location of the franchise unit, you should say so. If the franchisee is allowed to give some input into the decision-making process, you should indicate this. You should also be clear about whether you will be imposing conditions such as minimum sales quotas on your franchisees.

Franchise System Success

Is there any sure formula for franchise system success? The safest answer to this question is “No.” In business, there are never any guarantees when it comes to systems involving contextual factors like other people and entities. There will always be some element of the unpredictable about them. You can anticipate, speculate, and determine possible outcomes in your franchise system, and you can work towards them. In the best case scenario, everything will work out well and you will succeed beyond your wildest expectations. In the worst case scenario, an unexpected factor can undo all your well-laid plans, and if you don’t have any back-up arrangements, you will be in a fix.

This is not unique to franchising. It is the way of the business world.  You may plan, coordinate and implement arrangements, but there are no guarantees that you will profit. However, if you are open to creative ideas, and if you are willing to put in all the hard work necessary to get things started and then to sustain them, you have some hope of achieving success.  Subsequently, the key to doing well is to learn what conditions, decisions and actions were behind your prior mistakes, and then to avoid replicating them. Experience, whether direct or indirect, is the ultimate teacher in business. It is complemented by the courage to take calculated risks and the prudence to lay down a fall-back option ahead of time.

 

The Franchisee Factor in your Franchise System

 

For your franchise system to work, it will have to achieve a balance between meeting your own financial goals and ambitions and enabling your franchisees to thrive. As the franchisor, you will have control over such factors as marketing, franchise design and operation, and product quality. However, you will not have the ability to force your franchisees to work within the limits you have set. They will have to be amenable to the terms of your franchise agreement in order for your franchise relationship to work. They will also have to have managerial skills and abilities commensurate with the needs of your specific franchise. It would do you well to look into their backgrounds before selling franchising rights to them.

It is also important to give your franchisees a breathing chance when assigning them franchise territories. You might think that setting up numerous franchises in a particular territory will maximize your potential revenues. However, if you miscalculate, you will cause some of the franchises to go out of business. This will only undermine your franchise system.

Franchise Package

A quick internet search will reveal the term “franchise package” to be used in a variety of ways by different business entities. Some use it to refer to the documents initially given to those who are interested in learning about a particular franchise company’s franchising opportunities and applying to them. These may include a description of the franchising opportunity, a list of the factors determining the eligibility of potential franchisees, a form to indicate interest and apply to become a franchisee, and a form authorizing the franchisor to do a background check on the applicant.

 

Further examination of the term “franchise package”

 

Others may use the term to refer to the documents made available to those who are successful in applying to be franchisees. They include the franchise agreement and any other documents determining the terms of the franchise and governing the relationship between the franchisor and franchisee. These documents include a franchise operations manual, which informs franchisees about all dimensions of operating their franchises.  They also include a franchise disclosure document, which discloses to franchisees the rights to which they have access under the franchise agreement, and their obligations towards the franchise company. A franchise package can also include deposit agreements, multiunit agreements, financial statements, account assumption agreements and software license agreements.

The term “franchise package” is also used by some to refer to what one gets upon signing the franchise agreement and paying the franchise fee. This could include equipment relevant to running the franchise, training, and access to certain products and services. For instance, an ice-cream kiosk franchise package could include a business plan, a marketing plan, an operation guide, exclusive rights to a protected territory, storage cabinets, a machine for storing and dispensing ice cream, storage space and dispensers for various toppings, brand marketing, signs, menus, workstations, etc.

Whichever understanding of the term “franchise package” you encounter, you will find that it describes a franchisor’s overtures towards franchisees and potential franchisees. Thus, the franchise package gives applicants and franchisees alike insight into the franchise company’s degree of professionalism and its level of organization. A comprehensive package, incorporating all the necessary information clearly indicates that the franchise company is thorough and worthy of further consideration. It may also reveal that the company has been in the franchising business for long and has had the time to iron out the irregularities in its process. The better put together a package is, the more confidence that applicants and franchisees are likely to have in the franchise company. Thus, putting a package together should be seen as an opportunity to engage in implicit PR for the franchise company.

Franchise Expansion

Deciding whether to franchise your business in the first place is distinct from franchise expansion. The former entails a variety of steps to determine whether your business would succeed as a franchise business. It could end with you rejecting the idea of franchising and opting, instead, for smaller, more controlled growth. The latter involves a business that has already proven successful as a franchise business. Expanding this franchise business by opening more franchises in previously unexploited territories, regions, and even countries will make it possible to maximize the franchise company’s profits.

Sometimes franchise expansion is something that is considered as a long-term goal, right at the beginning of the franchising process. The franchise company typically starts small, expanding locally, and translating the franchise formula into success close to ‘home’ before considering larger conquests nationally and internationally. In this case, franchise expansion occurs in phases. This is a wonderful way to expand because, by the time the franchise company opens its doors to international franchisees or to franchisees in previously ‘unconquered’ regions of the country, it has established that it has potential for great success. This, more than anything, helps to win over potential franchisees who are shopping around for a franchise company to approach.

 

Some of the Complications of Franchise Expansion

 

Franchise expansion on an international scale brings into play issues that a franchisor probably has not had to deal with previously. One of these is the issue of the franchising laws in the country into which the franchise is expanding. Some countries simply do not have laws regulating franchising. Alternatively, they may have such laws, but they could be underdeveloped in comparison to the franchising laws that exist in the franchise company’s home country. The problem with venturing into new markets where franchising is not legally regulated is that legal issues might arise, putting the franchisor or franchisee in a position of great disadvantage. If this happens, then there is no legal basis for resolving these issues. Either party could incur great losses as a result. Franchisors are also likely to want to protect their trademarks and to feel concerned about their limited capacity to do so in countries that have poor franchising laws or don’t have any to speak of.

There are various models for franchise expansion. A particularly intriguing one involves partnering with a franchise business that already has infrastructure in the region or state into which you want to expand. This can be a mutually beneficial relationship, allowing each franchise company to benefit from the other’s infrastructure. It dramatically reduces expenses. However, it can create extra legal complications if it isn’t well-thought through and if the associated contracts are not drawn up well.

Franchisor Liability

Being a franchisor is not just about being at the top of the franchise system. Sometimes it also entails franchisor liability, that is, the fact of being held legally responsible for the actions of your franchisees.

 

Why is Franchisor Liability Even Possible?

 

You may be a bit confused about why a franchisor would be held liable when franchises are essentially independently owned and operated. The answer to that question is that, more often than not, franchisors exercise so much control over how their franchisees run their franchises that they could be said to be involved in the daily operations of the franchises. Thus, if a franchisee’s employee is implicated in sexual harassment, and if the franchisor can be shown, through his or her actions or documents, to have been involved in decisions involving the daily operation of the franchise, then franchisor liability could come into play.

This may seem unfair. After all, the franchisor may not have played a part in employing the individual who subjected his or her subordinates to sexual harassment. Furthermore, the franchisor may not even have been aware that this problem existed. This makes it apparent that being a franchisor carries its fair share of potential headaches. If you want to avoid being put in this precarious situation, then you need to seriously think about how you plan on structuring your relationships with your franchisees. You may want to protect your trademark and the reputation associated with it by giving your franchisees meticulous details to govern the way they run their franchises. However, the more detailed and prescriptive your guidelines are, the more deeply involved you are in the operation of the individual franchises. This is precisely the sort of thing that will result in franchisor liability.

Also, if you are directly involved in training your franchisees’ employees, you may be setting yourself up to be held liable for any illegal activity carried out on the premises of their franchises. It seems evident that minimizing your liability by taking a step back from deep involvement in your franchisees’ operations is your best option. You could make it clear (in writing) that the franchise guidelines you give them are simply suggestions. You should certainly restructure the language in all your documents to make sure that the individual franchises are not being identified with the franchise company. There should be clear distinctions between them because documents that conflate them could easily result in franchisor liability for franchisee actions.

Franchising Rewards

As you consider getting involved in franchising, you should consider what you stand to gain by becoming a franchisor. Franchising rewards have to outweigh the risks of franchising if you are to benefit from the experience.

 

Franchising Rewards and their Implications

 

So what are some of the rewards of franchising? To answer this question, it makes sense to think about what franchising entails in practical terms. Franchising essentially allows you to grow your business without bearing all the financial and logistical burdens on your own shoulders. In a sense, it is a division of labor and, in some ways, a distribution of risk. Because franchisees have a stake in the success of the franchise company, they are likely to invest more goodwill and energy than, say, an employee who is hired to manage a branch of a business. Thus, if the franchisor sells franchises to the right people, he or she will not need to stand over them and monitor them to make sure they’re doing things the right way.

A number of franchising rewards follow from the circumstances described above. One of them is the fact that franchising makes it possible for franchisors to slim down their operations for greater efficiency. It would be logistically and financially overwhelming for franchisors to own, develop and run different branches of their businesses in different cities from one central location. Franchising allows the decentralization of control and expenses. Hence, instead of all the operational decisions being made at the center, franchisees have the power to make important decisions while following a franchise blueprint. This sort of organizational structure can be tremendously efficient if the franchise blueprint is well thought out and if the franchisees are a good fit for the franchise company.

Other examples of franchising rewards are made apparent by the competitive capacity of franchise companies. As the previous paragraphs point out, franchising allows for the quick growth of a business. By buying franchising rights, franchisees invest their own resources into the business, making it possible for more stores to be opened and for the franchise company to grow a larger customer base. A franchise company with units in 50 different cities has greater competitive capacity than does a family-owned company with ten branches. The former is likely to fare better against competing businesses.

Other franchising rewards include the availability of more resources to devote to marketing research, the ability to save money by buying raw ingredients or goods in bulk and having them distributed to different units, and increased efficiency in staff recruitment and turnover.

Franchise Trademark

A franchise trademark is a word, name, image, symbol, device or combination that is intimately associated with a franchise. It is a brand name and should be registered to ensure that it is protected by the law. A franchise trademark is tremendously important because it is often the first indicator of a franchise’s identity. It distinguishes one franchise company from another and is used to show that certain goods or services come from a particular seller or provider.

To the average consumer, it comes to represent everything that a given franchise stands for. A good franchise company’s trademark often provokes a sense of comfort in a customer while a bad franchise company’s trademark is often enough to make customers walk away. Thus, it is important for franchise companies to guard the reputations associated with their trademarks by making sure that all their associated franchise units offer their customers top notch products or services.

It is also important for a franchise company to make sure that other business entities are not using its franchise trademark. Trademark ‘theft’ of this kind can easily dilute a brand name. Additionally, it can eat into a franchise company’s customer base by ‘stealing’ away customers and leading them to believe they are being served by an authentic franchise unit. It should not come as a surprise that various franchise companies have gone to court to sue others for the use of their trademarks.

 

What Makes a Good Franchise Trademark?

 

Because trademarks are so closely associated with the companies they represent, care should be taken in their design. A good trademark often ends up defining a company for life. So a franchise trademark should be able to tell customers what the business is about all within moments of the first glance. As franchising involves expanding an established business to reach new markets, excellent marketing and promotion are necessary to introduce the franchise to new customers and to ensure that they remember its trademark. In this case, a distinct trademark that is easy for customers to remember is ideal.

Most franchisors have the intention of leaving behind a business legacy that will last decades or longer. Thus, it makes sense for their trademarks to be durable. In other words, they should be as effective fifty years from today as they are at the present moment. Franchise companies that have to rebrand every 10 or so years lose something in the process. Companies that have the same logo 100 years on tend to be more appealing to customers. Their longevity earns their customers’ trust.

Franchise Termination

As you consider franchising your business, franchise termination is probably the last thing you want to consider having to do. However, you would be remiss to ignore this very important aspect of franchising.

Franchise termination is to franchising as divorce is to marriage. Just as a young couple blissfully in love might think it inconceivable that their union can end in divorce, franchisors might resist considering the possibility that their agreements with their franchisees could someday go sour. In both cases, hope and optimism are forefront on the minds of the parties involved. However, it quickly becomes evident that hope and optimism do not guarantee the success of any marriage or franchise relationship. Even in the best of cases, things can go wrong, and when they go wrong, it is important for there to be a well thought-out plan to follow. This is why it is important to address the possibility of franchise termination in the reams of documents that you put together for your franchisees to sign.

 

Franchise Termination’s Place in Your Documents

 

Devoting time to franchise termination in the documents that define and govern your franchise relationships is important because it lays out a set of guidelines that you can follow when it becomes impossible to sustain a franchise relationship. Considering that franchising often involves taking on large numbers of franchisees, it is reasonable to assume that this is going to happen with at least one of your franchisees.

The reasons that would inspire a franchisee to withdraw from a franchise agreement vary. Likewise, the reasons that would inspire a franchisor to terminate the agreement also vary. Because it is expensive to set up and to maintain a franchise in the first place, the reasons given for termination would have to be good. Backing out of a franchise relationship for frivolous reasons would simply cost the franchisor and franchisee too much.

Ideally, the franchise agreement or franchise disclosure document should detail the circumstances under which termination is justified, the steps that can be taken to remedy the problems, and, if they should fail, the steps involved in the termination process. The terms surrounding termination may put the franchisees at a considerable disadvantage, and, unfortunately, you may be tempted to use this to your advantage. However, you should be careful about this. It is relatively easy to cross the line into the realm of franchise fraud if you handle terminations in an irregular manner. So it is in your best interests to ensure that you clearly lay out all the franchising terms devoted to termination to your franchisees before they sign on. Subsequently, you should follow these terms to the letter if you end up having to terminate the franchise relationship.

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