Sunk costs: Sucked under by a franchise

drowningPeople do not realize that there are hidden dangers in small business and especially franchises.

You stay in a failing franchised business much longer because of a concept called sunk costs.

Sunk costs are investments that cannot be recovered once they have been incurred. You can’t get out of the water or reach the shore safely.

Most franchise investments are even worse because the assets are very, very specialized.

They’re called idiosyncratic sunk costs: assets that are highly dependent on the situation and the control of others. They may have cost you $1,000 but on the free market you could only get $100 for them.

Some examples are:

  1. a sign with a logo you do not own,
  2. proprietary software used for a specific system,
  3. a customer list that the franchisor owns (constrained by a non-compete provision),
  4. a telephone number that is controlled by someone else,
  5. leasehold improvements that are only useful to another franchisee (who is controlled by you-know-who),
  6. a current account balance that can be accessed by your franchisor,
  7. a centralized telephone system that someone can cut you off from, and
  8. specialized vehicles, equipment or the always highly elusive proven business system.

Almost all assets in your business are practically worthless if you fall out of favour with your franchisor. You keep treading water in the false hope that by serving your master, he will let you realize a high percentage of what you have sunk into the business.

Franchisees very seldom ever achieve a tiny portion of what they imagine their business will be worth because they are renters, not owners.

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4 Responses to Sunk costs: Sucked under by a franchise

  1. Carol Cross says:

    Yes! Because the start-up costs are so high and they are “sunk” costs, it would be difficult to sell franchisees if the start-up franchisees REALLY understood the RISK of the investment in terms of profitability and actual failure rate of other first owners. Because they are sold “a business of their own” they don’t understand that they are little better than a sharecropper who is working the brand and providing the work materials to work the brand and only the brand.

    When the lease costs are also figured in, as well, and the fact that these assets and the buildout can ONLY be used in the service of the brand franchisor, the trap is set. The malicious legal and long-term adhesory franchise agreement comes into play. The franchisor can’t lose because from the day you open your doors for business, he takes his contractual cut off of your gross sales and not off of your profits.

    The franchisee is merely a link in a chain and when the link becomes weak and starts to fail, the chain owner merely replaces the link or reinforces the link with another franchisee.

    Obviously, this is why franchisees are not provided full disclosure in the pre-sale process and are brought to sign these contracts with great hope and good faith that the franchisor is dealing with them in good faith. Additionally, franchisees believe, maybe subconsciously, that the franchisor would not require this kind of commitment and financial outlay unless he was selling something of great value.

  2. What do you mean I can’t sell it! Check out this guarantee:

    http://www.franchising.com/pressreleases/10902/

    March 02, 2009 // Franchising.com // Southbury, CT – In an unprecedented offering designed to create ‘worry-free’ opportunities for aspiring franchise owners, FranchisEsource Brands International, FSBI will now provide a ” peace of mind guarantee” on an investment in one or more of its 4 recognized business coaching brands – The Entrepreneur’s Source, AdviCoach, Business Partner Marketing Coach and Decor & You.

    “We’re so confident our franchisees can meet income, lifestyle, wealth and equity goals, that we’re willing to offer this unprecedented program in franchise history,” says Terry Powell, CEO and founder of FSBI. “Our established track record of 25 years, the proven initial and ongoing training, as well as our proprietary business success tools provide a solid foundation for our franchisees to build a successful business,” he added.

    The FSBI Assurance program is unique to the franchise industry and targets new investors who purchase one or more of the FSBI brands. If after following our system for 2 years prospective franchisees who participate in this program have not met their lifestyle goals, needs and expectations, FSBI will work with them to recover their investment by selling it to a prospective franchisee.

    Bloody

  3. Carol Cross says:

    There are sharks in the water! There will be a blood bath but the sharks will swim free after they have satisfied their hunger.

    FSBI will work with failed franchisees to try to recover their investment by selling it to another prospective franchisee???

    And this Press Release as referenced above is not an earnings claim made outside of the FDD and the franchise agreement, huh!

    Open season!

  4. Carol Cross says:

    Prospective franchisees in the United States don’t understand that while the FTC Rule makes it illegal, or something, to make “constructive earnings claims” outside of the FTC Rule/State FDD, this is just a joke. Under the FTC Rule, of course, there is no private right of action for doing this and enforcement of the prohibition is almost non-existent.

    Franchisors do it all of the time but, of course, they are protected from anything they say or imply outside of the actual signed franchise agreement and the FDD (the disclosure document because of the binding, uniform, adhesory, malicious legal contract that they sign in good faith —-believing that they can’t access the profits promised outside of the contract unless they sign the contract.

    In ALL franchise agreements, franchisors require the prospective franchisee to indicate and acknowledge that he/she has not been promised profits or success and that they aren’t relying on anything that isn’t spelled out within the four corners of the contract.

    The premeditated constructive fraud of the package of the contract and the disclosure document is not worthy of my great country and its people.

    Because I love my country and my fellow countrymen, I post to try to bring change, but I am getting discouraged.

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