Sunk costs: Sucked under by a franchise

March 1, 2009

drowningPeople do not realize that there are hidden dangers in small business and especially franchises.

You stay in a failing franchised business much longer because of a concept called sunk costs.

Sunk costs are investments that cannot be recovered once they have been incurred. You can’t get out of the water or reach the shore safely.

Most franchise investments are even worse because the assets are very, very specialized.

They’re called idiosyncratic sunk costs: assets that are highly dependent on the situation and the control of others. They may have cost you $1,000 but on the free market you could only get $100 for them.

Some examples are:

  1. a sign with a logo you do not own,
  2. proprietary software used for a specific system,
  3. a customer list that the franchisor owns (constrained by a non-compete provision),
  4. a telephone number that is controlled by someone else,
  5. leasehold improvements that are only useful to another franchisee (who is controlled by you-know-who),
  6. a current account balance that can be accessed by your franchisor,
  7. a centralized telephone system that someone can cut you off from, and
  8. specialized vehicles, equipment or the always highly elusive proven business system.

Almost all assets in your business are practically worthless if you fall out of favour with your franchisor. You keep treading water in the false hope that by serving your master, he will let you realize a high percentage of what you have sunk into the business.

Franchisees very seldom ever achieve a tiny portion of what they imagine their business will be worth because they are renters, not owners.

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