Risk Compensation: Why franchise laws & regulations cause more risky investing

January 27, 2009

noparachute1All franchise laws should be immediately repealed.

Everyone would be better off knowing that they’re in an airplane with an empty parachute.

Specific franchise laws give a false sense of security that, paradoxically, causes investors to behave in a more risky way than if there were no laws.

BTW: The push for franchise laws (with very rare exceptions) has always been by the franchisor and the franchise bar, not by franchisee investors or their advocates.

  1. The U.S. has had state and federal franchise laws for +40 years.  Alberta, Canada since 1971, Ontario since 2000. The outcome is the same: still very high investor risks.
  2. Relationship laws have existed since 1956 in the U.S. The toughest state law (Illinois) doesn’t seem to have had much positive effect, one way or the other.
  3. Direct regulatory federal laws in the U.S. and Australia, although they have the statutory power, are not used, except on the occasional token, hapless, no-name franchisor.

The primary mechanism that causes this INCREASE in risky investment behaviour is found in a theory called risk compensation:

Risk Compensation is an effect whereby individual people may tend to adjust their behaviour in response to perceived changes in risk…Another way of stating this is that individuals will behave less cautiously in situations where they feel “safer” or more protected.

The more we feel safe, the more risk we feel we can take on without additional costs. [Wikipedia]

Risk compensation is most clearly shown in studies of cars equipped with ABS brakes. The stated intent of mandatory ABS brakes was to reduce injuries and death due to collisions.

  • The irrefutable evidence, however, is that drivers (unintentionally, for sure) compensate for having ABS brakes systems by driving faster, following closer and taking corners more sharply (ie. they increase their risky behaviour).
  • The collision rates stays constant because of the human tendency to compensate for improvements not only in brakes but seatbelts, bicycle helmets and even parachute design safety improvements.

Note: Booth’s rule #2:

  • The safer skydiving gear becomes, the more chances skydivers will take, in order to keep the fatality rate constant.

Everyone’s first instinct is to cry for a law or an improved law against human behaviour. Risk compensation theory indicates that this is a fool’s errand and it is consistent with my study of franchise law over the last 10 years.

Opportunistic franchisors and their advisors know this human, perfectly non-rational characteristic to compensate for perceived “safer” situations.

Predators rely much more on their abilities to read human nature accurately, than do their prey. (It is wise to remember that there are only 2 principle ways to succeed: doing good work or cheating.)

Additionally, the Authority of the State is most clearly manifested in a law or regulation. Since the state holds a monopoly on coercive action (exercised by the police, military, courts, etc.), any franchise law signals a state “sanction” of sorts.

In this way, the state’s ultimate secular authority and legitimacy is attributed to the most poo-filled franchise system. It gives credence and camouflage to an industry without control or standards.

The Science of Persuasion: In the very important book Influence: The Psychology of Persuasion, Bob Cialdini calls authority his 5th of 6 “Weapons of Persuasion”:

  1. The logo of the FTC, the ACCC or the Ontario Legislative Assembly confers a legitimacy that can be exploited by some (badge of authority).
  2. Government guaranteed loans confer an aura that “This must be okay because the government and a Big Bank is risking their money, too” to even the most wicked scam (authority).
  3. The threat of  a lawsuit triggers (1) the fear of poverty and shame (bankruptcy) but also (2) of being perceived by other as behaving in an anti-social or near “criminal” way (social proof).
  4. Oh how charming everyone is, before you sign and how much you’ve become a shithead when you start to question the status quo (liking).
  5. How franchises that you should be paid to run, can instead be sold for 100,000s of  $ because of some “secret sauce” spiel (scarcity)

There is much hard science behind being persuasive that can be used for good or ill.

Take a look at this 3:11 video book review and imagine how Cialdini’s 6 Laws (reciprocity, commitment & consistency, authority, social proof, liking, scarcity) are used to snare franchisees.

Advertisements

Kiwi scams touch all classes of immigrants

August 23, 2008

The latest New Zealand Herald article on Blue Chip by Maria Slade [Immigrant banker put $1.7m in Blue Chip] is interesting for at least three reasons.

One, it points to a specific truth about fraud: all levels of class, education, access to financial counselling and sophistication are vulnerable:

  • 2,000 mostly seniors living on a fixed income and a millionaire British investment banker (Blue Chip) or
  • dozens of barely literate Indian and Chinese arrivals with Green Acres and Green Power franchises.

Quickly:

A British investment banker who came to New Zealand for a better lifestyle invested $1.7 million in 19 apartments through Blue Chip. Now Neil and Michelle Hickman are pinning their hopes on court action to recover some of their losses.

Mr Hickman gave up his career as a successful investment banker and moved his family to New Zealand two years ago, intending to live off his wealth.

Two, immigrants are considered prime protein by some franchise systems. New arrivals who invest large sums are often given special treatment [some expected; some not].

  • Several franchisors aggressively market their systems overseas to potential new immigrants using their government’s investor programs as a proven successful fraud technique: a badge of authority.

And three, for perhaps the most understated comment to date from a deeply betrayed person whose wife and three children are living in rented quarters while he goes back to work in Britain to make ends meet:

“Talk about a bad year,” Mr Hickman said.


%d bloggers like this: