Remember the feeling in your stomach when you imagined what would happen if your partner decided to bail on the relationship?
- This is exactly the problem with franchising: you are dependent and reliant on many people who know much more than you do.
In franchising you will enter into many relationships that by their very nature have hidden dangers. The source of the greatest danger is the economic reality of credence goods.
Credence goods relationships are commercial exchanges that have the following characteristics:
- the buyer cannot tell really well if he has a problem (can’t diagnose),
- the buyer does not know how much of the good or service he needs to fix a problem (can’t assign appropriate resources to solve problem),
- the buyer cannot judge the quality of the service they need or have received (even after paying for it) and
- the person providing the service knows your vulnerability and tends therefore (even sometimes unintentionally) to and persuade you what is in their (as opposed to your) best interests (see Credence Goods attracts Experts who Cheat).
Some examples in every day life are: your vitamin supplements, car mechanic, doctor, lawyer, and accountant.
Credence goods have a very, very important role to play in franchising.
Let’s specify the sources of vulnerability (others know more than you do) for franchise investors:
- often no small business experience (added to an arrogant attitude that running a SME is a no-brainer v. being an employee),
- no experience in vertical market of franchise (can’t compare; relies on franchisor’s support),
- there are much more monopoly or near-monopoly situations in franchising v. independent business (monopolist can charge more for lower quality: extracts economic rents from captive)
- monopolies create a moral hazard: others do not pay the cost for their actions (externalities),
- required to devote 100% of time to investment (all eggs in one basket),
- spouse and others often gets sucked in as unpaid labourers, and
- usually 1st time as franchisee (very few repeat mom-and-pop franchisees).
You’re on the short end of the information imbalance which creates an incentive for the other party to cheat (strip value from you).
- franchisee : salesman/consultant,
- franchisee : media [sponsor of Discovery Day],
- franchisee : franchisor executive [pre-sale honeymoon],
- franchisee : pre-sale lawyer [usually a dunce generalist but gives the pretense of wisdom],
- franchisee : current franchisee [most existing Ees know they will be punished if they are honest; so deeply into denial that they honestly believe their own lies],
- franchisee : supplier [assume cost savings are going to flow-through to them],