Franchising’s collapse: Tragedy of the Commons

July 8, 2008

The Tragedy of the Commons is an important concept that has very serious implications if you are thinking of buying or continuing to invest in a single-unit (Mom-and-Pop, $ as a high % of total personal net worth) business format franchise.

  • Investing [now] in any franchise is like feeding a corpse.

Why that is so is a complex question but one that should be asked. Briefly the Tragedy of the Commons is:

a type of social trap, often economic, that involves a conflict over finite resources between individual interests and the common good. It states that free access and unrestricted demand for a finite resource ultimately structurally dooms the resource through over-exploitation.

The fastest example would be air pollution. If you think this is just egg-head stuff you run the real risk of being wilfully ignorant with your life savings.

Such a notion is not merely an abstraction, but its consequences have manifested literally, in such common grounds as Boston Common, where overgrazing required the Common no longer be used as public grazing ground.

My position is:

  1. the lawyers have been, over time, so good at closing the loopholes that any hope for even legitimate remedy is practically impossible,
  2. the smart money has concluded some time ago that any franchise is too risky (too many types of fatal business risks v. independent businesses), and
  3. the industry becomes increasingly desperate for new sales.

As more and more people talk openly about their negative franchise experiences, the salesman can only increasingly prey on segments of our society that have not been fraud-proofed. There are no new pastures: they are all Wastelands.

The industry has, in my opinion, permanently and irrevocably destroyed their own means of survival. Every ecology has its limits.

  • Psychological denial is a cluster of behaviors and emotions that protects people from pain. It is most evident in the irrational outbursts (see shunning of Blue MauMau contributors) of experts with a career tied to the industry. Note: this emotion affects both “good” and “bad” actors [ie. the illusion of legal remedy enables delay of the inevitable burial].

It is a shame that the franchise bar, franchisors, salespeople, bankers, etc. have invested so heavily personally [education, reputation, status, income, identity] in a dead industry. But it ain’t no Greek tragedy, either as I know the quality of most of these men.

And it sure as hell needn’t cause you to join in their delusional thinking or fate.

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Trust but verify: Sometimes, seeing should not be believing

July 7, 2008

Dan Ariely makes some extremely important points about human decision making in this 1:54 video. I highly recommend his book, Predictably Irrational.

Try out a few of the visual illusions he demonstrates on his weblog. If your eye can be tricked so easily, Maybe Dan’s idea that we make many mistakes in decisions that even experience will not solve.

  • The idea of Decision Illusions may explain why so many pre-sale investigations result in catastrophic franchise investment decisions.

What a franchise system does versus what it says

July 7, 2008

You look and perceive the bricks-and-mortar of a store and conclude what a franchise “system” is and is not.

You search for information and start to look into it. Your heart or fear sometimes takes over.

Humans tend to accept some information and discount other data [confirmation bias] based on non-rational notions. The problem is we won’t know until it’s too late; after we’ve signed [hindsight bias]. Some deals are written in blood.

By looking you see what you wish to see, we deceive ourselves [wishful thinking bias]. We are sometimes aided by advertising we didn’t identify as propaganda.

The system is the means of mining value from the franchisor’s customers [franchisees]: Max. cash per unit of time. The pre-sale means are best accomplished by deceiving and encouraging self-deception.

  1. Modern franchisors are in the life savings appropriation business. They use the mask of an operating business to confuse.
  2. Franchising is marketed to those individuals who have sufficient (1) ignorance and (2) capital to make the effort worthwhile.
  3. Qualified investors sign franchise agreements that re-defines (degrades?) themselves as near-slaves in the hope of return [Faust or Deal with the Devil].
  4. When you become aware, you are unable to defend yourself [$, emotion, trust].
  5. Franchise bar members are paid handsomely to maintain the machine and clean up the mess.

Lately, people seem to believe that betrayal is without personal consequences.


In Praise of Bankruptcy protection

June 29, 2008

My 2001 personal and corporate bankruptcy was substantially pre-ordained the moment I signed the franchise agreement in 1998.

It was wishful thinking that I could be profitable as a Mom-and-Pop operator when I got hooked up with, what turned out to be (see hindsight bias) a system that didn’t have a proven business model. I kept putting more and more time and money in (sunk costs) believing I could turn the corner.

Michael Kernaghan of the Weed Man was right: I didn’t have enough money to grow the business quickly enough to be sustainable.

Once in the soup, I created an internal fallacy or illusion. It was fueled in part with my increasing attachment to the money I had lost (loss aversion) which is usually 2 times as powerful as the desire for a comparable economic gain (prospect theory).

It was very difficult to square this failure with the frequent successes I had had in my life up to the at time (cognitive dissonance). And the franchisor could always be counted on to counsel perseverance and asking relatives for more money.

  • Very Large Note: I had no flipping clue (at the time) that I was in a very real way acting in a delusional way. I thought I was being perfectly rational. I had did not know I had Drunk the Kool-Aid so badly. (Most other cult members don’t think so, either.

Whether a system is predatory or incompetent, it does not matter: The investor will lose it all, in all likelihood. The only difference will be the style you exit with.

Bankruptcy

Of the tens of thousands of dollars I have spent on professional advice, the most useful franchise expenditure was with my Bankruptcy Trustee.

He once mentioned that the average indebtedness of a client was $25,000.

My former franchisor realized less than seven per cent (7%) of their claim on my business’s disposal. That was no surprise to a 1,800 franchisee multi-brand international corporations.

Observations

  1. I believed I could turn early losses around by working harder and investing more. I was wrong (see pride). Perversely enough, the harder you work, the more you become attached to being a franchisee. It works like a Boy Scout knot that tightens as you struggle with it.
  2. I went 3 to 4 years too long. They call it “protection” under federal law for a very good reason. I was over-optimistic.
  3. Bankruptcy was the best business decision possible.
  4. The manner in which I bailed was important to me (no credit card debt, only the likely suspects got burned).
  5. My spouse never signed anythingever. (Everyone notice this?)
  6. My retirement savings were with a life insurance company which, for me, proved to be beyond the reach of bankruptcy law. (Talk to your financial advisor about protecting yourself before investigating anything.)
  7. Going independent delayed the inevitable and it allowed me to acquire the start of my franchising education.
  8. Financial counselling before I actually declared bankruptcy (ie advice in helping to decide) from a Trustee in Bankruptcy was the 2nd best money I ever spent.
  9. Bankruptcy’s stigma (acting through the human emotion of shame) kept me going. I thought that if I was going down, I may as well learn as much as I could about franchising as I went.
  10. Industry insiders told me stuff that they never imagined I would using in 10 years. Everyone cuts a deal, signs a gag order and exits feeling it was mostly their fault.
  11. I got hooked on learning how this trap is laid, especially the psychology that makes a franchisee seem to so comprehensively collaborate in their own imprisonment (thought reform).

Credit counselling is a part of the process of being a first-time bankrupt. It went pretty smoothly for me.

When my counsellor said, “What lessons have you learned, Les?” and I replied: “Don’t buy another franchise?“, the questions stopped.


Study those who Engineer the Trap

June 28, 2008

A senior solicitor with the New Zealand law firm Buddle Findlay made a very accurate observation about investing in a Kiwi businesses.

The solicitor (Kelly Foley) was quoted in a terrific little article by Tina Law at http://www.stuff.co.nz called Subway franchisee faces bankruptcy.

“The Subway chain follows standard New Zealand business practices,” Foley said.

Whenever I see professionals offering exceptional information, I will be sure to point it out to my loyal readers.

Why not give the article a quick read and see what you think of Ms. Clements’ situation? I assure you there are perfectly rational reasons [sunk costs, risk aversion, decision making biases, heuristics, persuasion, etc.] why so much capital was re-distributed since 2005.

This type of failure happens every day in franchising.

  • The contract gives the legal right to lie, cheat and steal the moment the 1st one was signed. [They knew it; she did not].
  • The capital was simply moved across the table over a relatively short time.

Disclosure: I lost $135,000 in 18 months in a stupid landscaping deal. Not proud of it but not ashamed for falling into a well-designed trap either. I’m the one with an M.B.A. [Master in Blind Ambition], had run 5 independent businesses before, took 6 months to complete due diligence at PriceWaterhouse, achieved 24% of my sales projections over 4.5 years, flamed-out at trial, paid the lawyers and then went bankrupt.

I’ll be coming back to this article because it shows how churning can happen to extremely intelligent, hard-working and rational franchisees.

  • You decide: Wanna invest your life savings in any New Zealand franchise?

[Oz? U.S.? U.K.? Canada?]

Am I am bitter? Sure; a bit but that still doesn’t mean I can’t have thought some of this stuff through after 10 years. Rx: Overconfidence Effect, Cognitive Biases


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