Free riding problem in franchising

 

Without franchise bankers, modern franchising would not exist.

The free rider problem manifests itself in two principal ways within franchising.

One, franchisees can free ride (rip-off) the franchisor by taking the benefits of being within the system but not paying the price (royalties, ad fund, margin on COGS, etc.).

Two, franchisees can cheat by ripping off their peers; other franchisees within an independent franchisee association, IndFA. This, again, is done by taking the benefits (business & legal research, franchisor attention) while not contributing their fair share.

  • The single most factor in a franchisee’s investment is a professionally managed and adequately resourced IndFA. Without an IndFA, franchisees are hopelessly helpless in a competition of competence with the most half-baked franchisor.

Incentives must be created to encourage franchisees to support early, co-operate and hold their counsel. Many small businesspeople initially think of an IndFA as a type of union which needs to be overcome.

Franchisees often too narrowly define their business relationships.

  • They start looking at the franchise agreement when the first storm clouds appear and, poof, they become a 20-year franchise law expert. Sorry folks: the business wags the law, not the other way around.
  • An IndFA starts with an embryonic leader and informal executive which needs to be supported ($ and sense). There is a lot of work to do in researching the characterisitics of each trademark system and that needs to be done by a competent expert. [Think of it as a one-time information capital cost: Very cost-effective as a % annual sales.]
  • Modern franchising would never exist if the industry only was made up of franchisees and franchisors. Without a banker, neither could exist. Without the law, the same. Any industry stakeholder should be invited to the table: Otherwise, they’re free riding [making money without contributing].
  • Traditional and non-traditional suppliers to franchisees are an important, but hidden revenue-generation source for an IndFA. A shrewd executive starts looking as far down the road as the franchisor does.
  • Most franchisors will not welcome the formation of an IndFA with open arms. There are some defenses to a short-sighted franchisor response and the greatest is the integrity of the executive and its advisors.

Keeping your nose to the grindstone [without binding together] didn’t work then. And it doesn’t work now.

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