Franchising is much riskier than independent business

The franchise industry is well-known for its hyperbole bordering on propaganda.

For the latest example of these half-truths and silent misrepresentations see a recent modestly named article: Franchising to the Rescue.

In my opinion, this is an unnecessarily biased and dangerous article for small business investors.

It’s assumption is that franchising is a safer investment than independent business. That claim has been exploded for at least 10 years and totally ignores the recent New Zealand experience with Blue Chip and Green Acres.

  • No mention, either, of the two Australian state franchise inquiries and the upcoming national Oz industry probe. [see an excellent Oz resource, BakersDelightLies.com]

All the credible academic research comes to the opposite conclusion: Franchising is much riskier than independent business.

Research: There is an big quality difference between true academic work [published in refereed journals, funded by public money] versus private research [biased, paid for by interest groups]. It is not enough to say that there are no reliable statistics and then go ahead and spout off unsubstantiated figures.

  • Everyone knows the public remembers the numbers while forgetting the qualifications.

Publishing these self-serving guesses [with zero opposing opinions] is bordering on reckless media behaviour. Mom-and-Pop investors are risking their life savings and homes, after all.

Timothy Bates: In 1996, this university professor published an academic study that rocked the franchise industry. Bates was contracted by the Office of Advocacy of the U.S. Small Business Adminstration to look at survival patterns of franchised and non-franchised businesses.

Survival Patterns Among Franchise and Nonfranchise Firms Started in 1986 and 1987 concluded the following [see S.B.A. Research Summary, Related Bates paper]:

  • young independent small firms had a better chance of surviving than small, non-corporate franchises,
  • while franchise firms were better capitalized than non-franchise firms, about 62 percent of the franchise firms survived, versus 68 percent of the non-franchise or independent firms,
  • average profit was much higher for the independent businesses; profits were negative, on average, for the franchise firms,
  • franchises purchased from a previous owner were riskier than franchise firms started from scratch, and
  • only 49 percent of the franchises started by women in 1987 were in existence in 1991, compared with 67 percent of the independent firms started by women.

Within the report itself, Bates said:

…the franchisee route to self-employment is associated with higher business closure rates and lower profits for the young, largely noncorporate firms, relative to independent business ownership. p. 8.

U.S. Government: On June 24, 1999 Dr. Bates appeared before the U.S. House of Representatives’s Subcommittee on Commercial and Administrative Law. The Oversight Hearings on the Franchising Relationship were called to review the state-of-the-union in American franchising. Click here for a .pdf copy of his testimony.

Bates:

Findings of my research indicate that new and small franchisees are more likely to discontinue operations than independent startups, and this holds true when firm and owner traits are controlled for statistically. One clear-cut finding was that franchisees starting by purchasing the firm from a previous owner were riskier than franchisees starting from scratch. A person entering self-employment by purchasing an ongoing franchise risks acquiring a firm that is more likely than a de novo startup to go out of business within the next few years. [my emphasis]

These Kiwi industry gentlemen know all about

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One Response to Franchising is much riskier than independent business

  1. Carol Cross says:

    This “disinformation” program of the IFA and other interested parties concerning the performance of franchises for franchisees is clever and difficult to expose. A half truth (such as franchises stand longer than independents and are less risky) is not a lie, no matter how misleading, and business reporters and business newspapers and magazines are always looking for “product.” The Press Release and the Interview and the Website is cheap advertising for franchisors who are permitted to advertise and sell their franchises as valuable investments outside of “Truth in Advertising laws.” The FTC is responsible for regulating advertising on the Internet.

    Franchisors are allowed and encouraged to use their disclosure document, the UFOC, now the FDD, to imply that the Government is endorsing their franchise as long as they disclaim that they have promised any success and profits to new buyers of franchises outside of the disclosure document. Yet, they are not required under the FTC Rule to disclose earnings or any unit performance statistics in the FDD to new buyers. The majority of franchisors do not disclose earnings or any performance statistics of their units to new buyers of their franchises after over 30 years of the FTC Rule.

    The SBA guarantees loans for franchisees of franchisor systems that have very high failure rates of first-owner franchisees and franchising grows in our economy and in the new jobs numbers released by government. Retail franchise jobs are low paying jobs with no future and no benefits.

    The red herring of the statistics that franchises are more successful than independent businesses has helped to sell lots of franchises and, of course, has helped to divert attention from the hard reality produced by reliable research for the SBA that all startups, independent or otherwise, of all small businesses suffer high failure rates over a period of ten years when only about 29% are still standing. (When franchisors are aware of this, the requirement for ten year contracts and ten-year leases seems truly malicious and self-serving.)

    I thought it was brave of Scott Shane of Western Reserve University in Cleveland to blog about this on April 28th, 2008; i.e. Startup Failure Rates, and posted a few questions to him as comments that he has not yet answered. Obviously, the business model of franchising, when churning is possible, does permit some franchisors to overcome the odds and to grow their systems to gain market share and to beat the odds for a longer period of time than the independent business operator.

    Obviously, this is why government supports franchising and sacrifices the franchisees, as necessary. I understand that this public policy is considered to promote the “greater good.”

    But, I join Susan Kezios of the American Franchisee Association in asking why unit performance statistics are not disclosed and why are franchisos of same and similar concepts not required to compete for the cheap labor and cheap “venture” capital of prospective franchisees? As Susan Kezios asked over ten years ago, “would this be a bad thing?”

    Like

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