Food truck encroachment: Why sunk cost investments and change kills mom/pop franchise life savings

A legal civil war will mask franchising’s unavoidable investment flaw: opportunism arising from inevitable change.

The #1 business risk is franchisor opportunism: the self-interested exercise of contractual discretion via deceit. This one risk comes cloaked in hundreds of types.

Systemic Factors: At one time, franchisees were granted a geographic monopoly but that ‘s history, mostly. Franchisees own the majority of the assets but franchisors control the use/exit of this capital. Franchisors take $ from the top; franchisees only from the bottom. Pre-sale due diligence is irrelevant because the franchisor reserves the right to unilaterally change the model. Sunk cost chains draw off-balance sheet capital in from all s0urces of “love money”.

High-end, branded roach coaches will be franchisors’ new crack cocaine:

  1. lower capital barrier to sales (easier financing),
  2. boost total market retail sales (royalties/ad fund %),
  3. product sales margin increases (tied buying provisions),
  4. same control via central commissary innovation and tied buying to outfitters,
  5. 100% flexibility (scaled territories),
  6. streamlines process when an intentional insolvency is chosen,
  7. centralized social media promotion, and
  8. margins by contracting with a secondary space rental company (more than make up for franchisors giving up hefty lease margins).

Benefits for traditional mom-and-pop investors?

At best, a generous offer from your franchisor for you to buy 3 new trucks to replace your outdated bricks-and-mortar store.

I would suggest that billions of $  existing franchisee-owned assets just shrunk. Permanently. Never to return.

Think: Dunkin’ Donuts, Tim Hortons,  Quiznos on wheels.

Thanks for the tip, Michael.

3 Responses to Food truck encroachment: Why sunk cost investments and change kills mom/pop franchise life savings

  1. Carol Cross says:

    Sure! The franchisors will encroach on franchisees as needed and make demands on them to test new concepts and compete in saturated sectors to always grow the franchisors’ EBITDA’s. If the big- brand fast- food franchisors start trucking to sporting activities and celebrations and parades, etc.. you can bet that franchisors will compete and it is the franchisees, as always, who will take the risk and test the waters.

    But this idea may not go over just as food/meal preparation franchises and food delivery franchises that looked like good ideas were mostly failures.

    Because of the OPPORTISM and the SUNK COST REALITY inherent in this business model, even if franchisors had to disclose risk factors in terms of unit performance before the purchase of the franchise, the risk to the franchisee can never be known. As Les Stewart says “Unsafe at any brand.”

    http://thegreatfranchisingrobbery.blogspot.com

  2. Les Stewart says:

    Carol,

    You make a solid case for franchising allowing franchisors to externalize or download their business risks onto the franchisee.

    Another form of externalization is the “off-book” nature of private equity purchases of franchise systems. Experienced financiers know that the total free cash flow is much greater when there are franchisees because of the franchisors’ abilities to over-reach and, at worst, have the franchisees subsidize their stores by unwanted additional investments in donated family labour and life savings.

    The ability for franchising to make a franchisee stay even though his average selling price is LESS than his variable cost, makes secuiritizing franchise systems much, much more attractive.

    In effect, the PE vulture leverages as much as the above-board market allows while forcing hidden leverage on the franchisees’ future balance sheet.

    Military veteran franchise programs such as VetFran “tap” into retirement cash flows that are, of course, as certain as there is a national government.

    Les

  3. Carol Cross says:

    Yes! The Vet-Fran Program and the Patriot Express Loan Initiative of the SBA acts as an endorsement of franchising to Vets and their families who are USED to stimulate the bad economy. What kind of workplace violence may we have in the future???? when the Vets may come to understand that they were just offered up as a solution to producing jobs in the recession and maintaining and growing the EBITDA’s of the franchisors.

    It appears that the PE vultures, the corporate raiders, have accounting law and bankruptcy law on their side and investors don’t understand how to read financial statements. The effect of the New Goodwill Accounting Rules on Financial statements in 2001 sure opened the door for the corporate raiders. Whole business securitisations of franchisors appear to remain attractive to PE C

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