They think they’re Owners: Why franchisees delay in bailing

Franchisees stay in money-losing operations much too long because they make a fundamental error (own versus rent).

They see themselves as “owners” of their business, while in fact, they are conditional renters of trademarks and an operating system.

  • This makes them overvalue their investment and continue to invest much, much more of their own personal identity in the business.
  • This is particularly true because the new renter is much less likely to share in that inflated worth.

This mismatch makes a negotiated sale much less possible, without adding in all the self-interest and network issues that the franchisor can bring to the table.

This video from Dan Ariely (Predictably Irrational) shows some research that was done that tends to support my conclusion. Summary:

  1. owners (sellers) would sell at $1,400, while the
  2. buyers valued the tickets at only $170.

Those that thought they were an owner, inflated their value by 8.2 times the market value.

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3 Responses to They think they’re Owners: Why franchisees delay in bailing

  1. Interesting, but I don’t think that the endowment effect is what is working here. I see more sunk cost fallacies.

    First, franchisees don’t see themselves as owners because they constantly look to “corporate” for business solutions.

    Second, the refusal to sell and move often means confronting losses.

    But, you are right to emphasize the renting or leasing aspect of franchising. I wish more people would realize this.

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  2. Les Stewart says:

    Michael,

    I’m not so sure.

    (1) Many franchisees have never run a fulltime small business so they think its perfectly normal to look elsewhere for assistance. That is what is promised, is it not? And let’s not forget how persuasive promises, semi-threats and reassurances from the franchisor for your continued patience, market reversals and for you to “hold on just a little longer”, can be within the situation. The sociology or group dynamics of persuasion are not appreciated very much, I think.

    (2) To define a situation as a sunk cost problem (which post-sale additional investment surely is) does very little in assisting with decision making. That marginally useful new equipment that is $2,000 overpriced is simply another in the accumulated chain of what is sunk already ($100,000 + 2,000).

    (3) Absolutely: prospect theory has a large part to play but I think the fact of such am “end of days” scenario (personal and corporate bankruptcy) is a difficult fact to actually make a decision on.

    If franchisees in deadbeat systems were to act rationally, we would expect massive abandonments. If 1/3 of franchises do either: well, marginally or openly bleeding out, you’d expect to see, what, 50% leave each year (not achieving a market ROI commensurate with risk). We don’t see that because the ties that bind to false ownership are poorly understood.

    Example: I think about a conversation with a franchisee on a lawn in Oct and I think he was half serious when he said that lawn care businesses were sold in his system on a $1 sale per $1 unit sales which would have amounted in his case (in his mind) at about $400,000. And this is notwithstanding the ON government outlawing the use of pesticides by operators (key barrier to entry and industry KSF).

    He would have easily agreed that maybe $400k was on the high end: Maybe only $350,000? But he was anchoring in that range. This was done to allow him to maintain hope while working 70-80 days. His denial is expensive in that it corrodes his rationality and his potential to join with his peers.

    The idea that his customer list is worth $50,000 max plus some beat trucks cannot be held in his mind while is functioning (cognitive dissonance) especially when he subtracts the formal and love money debt down stroke.

    By becoming increasingly passive and helpless, he can at least point to the big bad wolf franchisor to explain to his father-in-law why he can’t pay back his loans.

    The belief of a $350 to 400k lottery payout is certainly a phantom dream. It serves the franchisee’s ability to function within the trap while delaying the inevitable. The individual franchisor willingly becomes the bogey man as the price to pay for extending the hamster’s time on the wheel.

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  3. Carol Cross says:

    I guess I missed these comments the first time around.

    Failing franchisees or those who have struggled for years and are teetering at break even don’t have any easy exit strategies, and struggle inside the “noose” for a long time.

    This, of course, is by design of the franchisor and the Regulator, who enables the franchisor, who WINS all of the time the franchisee is struggling to keep the business alive. Maybe the statute of limitations will run out and there will be no valid “breach” claims that the failed franchisees can afford to bring against the franchisor. The 5% or less who survive with resources to hire attorneys are not really any kind of threat to franchisors who have been sold “fraud insurance” by the regulators.

    I’m sure that Michael Webster knows that the usual boilerplate franchise agreement is a malicious legal trap for the franchisees and that franchisees have NO idea how some of the apparently innocent terms will be applied by the franchisor in the final assault on a failed franchisee.

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