The franchisee lifestyle can change but your sunk costs do not.

Due diligence is like taking a picture.

It’s only good for a certain specific time.

Business risks change; sometimes dramatically during the relationship.

Risks change: Pre-sale due diligence does not

Just like entropy (going from order to disorder), things in business normally turn to shit.

Business risks increase (19 out of 20 times…) as the franchise agreement runs but your sunk costs keep you hooked up to a babe that’s turned into a wolf. Every half-baked new cash-grab scheme, you’re “All-in”.

But that does not stop the thought machine, sometimes run by “world class” CDN franchise bankers.

• Steve Iskierski, Senior Manager Franchising, BMO Bank of Montreal

– Thanks: Wolves of Wednesday on ThisIsntHappinesss.com

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At best, a generous offer from your franchisor for you to buy 3 new trucks to replace your outdated bricks-and-mortar store.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

• Food trucks are rolling into the mainstream: Restaurant chains such as Sizzler and Subway are joining the parade of roving gourmet kitchens that started with Kogi two years ago., Sharon Bernstein, LA Times
• Streetza Pizza Social media, event planning.

Thanks for the tip, Michael.

It’s a sin tethering your life savings to easily copied core products

Jamba Juice‘s response to McDonald’s getting into their core smoothie business is clever but ultimately futile.

Problem with succeeding at 1. and 2.:

1. create a new consumer niche,
2. work to broaden appeal and
3. watch as THE corporate ideology gobbles it up.

The erosion of franchisee-pioneers’ sales are no laughing matter for Jamba Juice or all the other smoothie-dependent investors.

Equity in business: Who wants to buy you out of your death-struggle with a nearly-unassailable, cultural icon with an almost perfect record of supply management brilliance ?

Pure martyrdom.

A man in debt is so far a slave.

When there is an Independent Franchisee Association present, most people figure that members are best split into two camps. Those that are:

1. members (pay their share) and
2. non-members (free riders).

[This mindset is the greatest obstacle to effective advocacy, btw.]

The only real, relevant differentiating factor is:

• those who are slaves (ie have a killer amount of DEBT) and
• free men; those little or no debt.

The behavior of franchisees has much more to do with their perceived debt load (v. than their character).

With enough debt, any saint becomes a sinner.

Guaranteed. 100%.

– Ralph Waldo Emerson (1803 – 1882)

Blazing Saddles shows franchise relationship in 6:34 minutes

Pure genius.

For those with a significant tan, one thought:

Q: What is the shovel in 2010?

A: Email addresses.

• Blazing Saddles, Sunk costs

BTW: Credit-where-credit-is-due: Councilman posting over at Blue MauMau.

3 Classes of Risk: The Known, The Unknown and The Unknowable

Any business has to manage risk.

Before you start an investment, you need to add up all types and then compare them to the likelihood of achieving returns to see if the proposal makes sense to do.

In franchising, you cannot do this with any degree of accuracy before you sign.

Your investment is often tied (a sunk cost) to a losing concept of a self-interested franchisor.

Your debt will be used to make you comply to others interests; not your own.

1. The Known Risks: research your brains out by interviewing current franchisees, make sure the technology is okay, study the vertical market the proposed investment would operate in, do 5 years worth of monthly cash flow statements, talk to lawyers, accountants, former franchisees.  Get some type of idea.

2. The UnKnown Risks: these are real but discoverable. These are ones that come as a surprise that you need to find out before you sign. A good defense: take a minimum of 6 months; do not be pressured into signing. The  best defense is to work as a labourer within  a franchise, for free if you must. If you don’t think you can afford that investment in lost wages, believe me, you can’t afford to be a franchisee.

The Unknowable Risks: these are real but you (or any mortal) cannot quantify or scale them. They’re random but when they strike, they knock you out of the whole game: all your labour, 90% of your investment…all of it: gone. People (especially young people) think that the world is rational and foreseeable. It is not. There are winners in franchising just as there are winners at Casino Rama or Vegas.

Some examples:

1. a nice franchisor sells out/retires/decides/is forced to give control to someone not so nice or patient,
2. your VP of government relations cracks jokes about your corporation killing 22 Canadians (food poisoning),
3. your store is a staggering success and the franchisor wants it for his own,
4. you are smarter than the franchisor or his heirs (become a threat),
5. after years of 3 to 4 hours sleep you drive your truck into a group of children,
6. physical illness requires you to leave (the franchisor picks it up for a song and flips it in 3 months),
7. the new territory manager decides he likes your store and he happens to be the franchisor’s brother-in-law,
8. the franchisor racks up too much debt so decides to go insolvent to shake off his creditors,
9. you spend all your time at work and become divorced (Can you divide your net worth by the number “2″?),
10. you talk to a few of your peers and get terminated for trying to better your business,
11. your tradename is sabotaged by some food tampering incident showing up on YouTube (Domino’s),
12. you’re a Petland franchisee and a photo of 2 drowned bunnies  goes onto Facebook (above and here),
13. the W.H.O. decides tanning is a deadly health risk,
14. a competitor contracts for a social media site to trash your shared tradename,
15. etc., etc., etc.

Franchising is awash with unrecognized, rapidly increasing business risks.

These are all real life examples I have seen that are featured on WikidFranchise.org case studies.

All aboard the McShip of Fools: Das Narrenschiff

Buying a franchise is a real trip.

1. Really good writing survives a very long time.
2. Lies move quickly but truth lasts.
3. Lies do not become true over time, no matter how many times they are repeated by shills.

In 1494, a German theologian and lawyer wrote a best seller called Das Narrenschiff (Latin = Stultifera Navis, English = Ship of Fools).

Why Brant wrote this is fairly apparent in the prologue:

For profit and salutary instruction, admonition and pursuit of wisdom, reason and good manners: Also for contempt and punishment of folly, blindness, error, and stupidity of all stations and kinds of men.

It is a classic piece of literature that was instantly popular and still speaks of mans universal tendency to act foolishly (ie. to set sail on a journey of self-delusion).

Note the hat symbolism: the donkey ears.

Brant used satire to point out the abuses of power he saw in the state and the Roman Catholic Church. He did that to keep his head attached to his neck.

I chose the fool theme here at FranchiseFool and on WikidFranchise.org (thousands of case studies) to draw attention to the hypocrisy and dangers within modern franchising without being sued for the 3rd time. My message is ultra-serious but I need to teach in an indirect manner.

Any legitimate industry or authority should be able to handle satire from one person.

Historically, another role of a is to speak truth to authority.

Franchise “leaders” cannot tolerate my persistence that mom-and-pop franchising is the height of folly: It’s Unsafe at any Speed because the franchisor can strip value (exercise unilateral opportunism) while you have little or no defence to protect your sunk costs.

When you hear anyone say either:

1. But no one can predict the future or,
2. that person lost money and is therefore untrustworthy or,
3. He’s just antifranchising…

…that is a best indication you’re dealing with a 100% genuine jackass travel agent.

Sunk costs: Sucked under by a franchise

People 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.

Pizza franchise sold on internet for $181 NZ

Q: How much is a used “high quality” franchise worth these days in New Zealand?

A: $181.00

Franchisees operate their businesses thinking that they will recoup their investment when they sell. Many operators accumulate big losses in the hope of hitting the jackpot when they sell.

1. It almost always never happens.
2. Your money is sunk in the business and you will never get it back
3. Every franchise should pay it’s way and then some or be exited, immediately.

Case in point: $181 restaurant bill? I’ll take the works. Ms. Theresa Cowan placed an internet bid and won:

…an online auction for a 60-seater former Spagalimis pizza restaurant in Christchurch’s Northlands Shopping Centre for a bid of $181.

1. But surely the franchisor is concerned about the value of his businesses being worth almost nothing? Well:… not that you’d notice.

Spagalimis director Andrew Cooper said that despite the mall branch having a $400,000 fit-out four years ago, he was happy with the $181. “We would have given it away really,” he said.

Mr. Cooper is just happy the franchisor is off the hook for the lease obligations as a franchisee subleases from the franchisor. No word about the bank’s security on the equipment or leasehold improvements: probably not able to squeeze any more cash from the exiting franchisee, anyway.

• But still: assets worth $400,000 dropping to $0 in 4 years? What kind of bozos did the lending valuations? HINT: Close friends of the lender and franchisor.

2. Spagalimis Italian Pizzeria proudly lists themselves as:

• a member of the Franchise Association of New Zealand, FANZ,
• having a total of 5 NZ outlets (5 worldwide),
• and requiring investments “from $250,000″.

They even have a section called: Franchisee Comments that quotes Jerome Britt, Colombo Street Spagalimis as saying: ‘ Great brand, fantastic systems’

3. FANZ says this on their website:

Franchising is a respectable and highly successful business format, both internationally and here in New Zealand. Franchising is the safest way to buy a business.

I wonder what the former franchisee that got $0 for his $400,000 investment thinks about franchising in New Zealand? Or Mr. Britt when he sees the market for the sale of his business drive to zero.