Why do franchisees stay in a money-losing ventures much longer than an independent business person would?

February 19, 2015

It’s because of the actual nature of franchising.

Problematic Hadfield

Specifically the sunk cost investment dilemma that manifests itself in franchisor opportunism.

B. The Franchisee’s Problem: Opportunism
… An unrestricted exercise of control by the franchisor will favor the franchisor’s interests over the franchisee’s and create an equally significant problem for the franchisee: risk of opportunism.

For the franchisee, the most significant economic feature of franchising is the allocation of capital investments. Franchisees are distinct from ordinary employees because they have made capital investments in the business. These investments, however, are normally highly idiosyncratic, meaning that a large fraction of the franchise assets often have a greatly diminished value if employed in another line of business. Consequently, the costs of establishing a franchise are effectively sunk costs, which, once expended, are not easily recovered if the franchise goes out of business.

Sunk costs play an important role in creating the incentives that operate within an established relationship. This is best understood by considering the difference between fixed costs (overhead or up-front costs) that are sunk and those that are recoverable. For example, consider a business in which a variable cost of production has increased dramatically, so that the highest price in the business can charge for its product covers only the marginal cost of producing it, leaving nothing to contribute to fixed costs. Although the business can cover its variable expenses, such as wages and ingredients, it is making negative profits because it has nothing left over on its investment in overhead assets. If the business can resell these assets to recover its fixed costs, then the business can raise its profits to zero by shutting down and selling off the assets. If, however, these assets are sunk assets, then, by definition, their sale will not recover their full cost; shutting down will still leave the business with negative profits. If the business has any revenue left after paying variable costs to defray the cost of these assets, the profit-maximizing decision is to continue to operate, instead of junking the assets entirely and losing the whole investment. The key difference is that a business with recoverable fixed costs will shut down as soon as it shows losses, employing its capital more profitably elsewhere. A business with sunk costs, on the other hand, will continue to operate even though it has never recovered its investments in fixed costs, and it will not shut down until the amount it is losing exceeds what it would lose by simply abandoning the investment. [my emphasis]

The incentive that causes a business with sunk costs to stay in operation despite losses makes franchisees vulnerable to franchisor behavior known as “opportunism.”. Because the franchisee will continue to operate even if it is not recovering its sunk investment, the franchisor can make decisions that induce such losses without the franchisee going out of business. When these decisions benefit the franchisor at the expense of the franchisee, the franchisor opportunistically extracts a portion of the franchisee’s sunk costs. A franchisor can potentially extract this value from the franchise directly in a number of ways: it can raise the price of goods sold to franchisees, increase rent, boost royalties through an increase in the required volume of a franchise, levy fees, or divert advertising funds to general corporate uses. Extractions can occur indirectly as well. To increase the price of new franchises, a franchisor could require franchisees to make excessive advertising investments, to participate in promotional programs which are not cost-effective, or to undertake unnecessary renovations.

Just as the risk of free-riding makes control a central concern for the franchisor, the risk that franchisors will extract sunk costs makes opportunism a central concern for franchisees. These concerns meet head on: Where franchisors seek to expand their control, franchisees seek to erect boundaries. In some circumstances a franchisor’s decision to require increased advertising by franchisees, for example will reflect a legitimate exercise of franchisor control to overcome free-riding. But in other circumstances, it will reflect only opportunism.

Excerpt from Problematic Relations: Franchising and the Law of Incomplete Contracts, Gillian K. Hadfield. See full 1990 Stanford Law Review article on WikiFranchise.org

Many decades of very profitable franchisee relationships can

turn on a dime

when the franchisor decides to exercise their discretion in a more self-interested way.


What is preventing Tim Hortons in Canada from becoming a “down-and-dirty CCAA“?

January 30, 2015

Radical re-allocations of wealth require a conducive environment.

PatrickGibbons

Patrick Gibbons: “We want to grow together. My measurement of success will be how many millionaire franchisees there are out there.”

Companies’ Creditors Arrangement Act, CCAA, Industry Canada

Case: Country Style


Franchising creates and enforces a caste system

February 11, 2011

Franchisor opportunism can be both very rare and effective in enforcing obedience.

Obedience is enforced by controlling intra-species and inter-franchisee communication and contact.

Annual meetings, bulk emails, newsletters, site visits and faux franchisee-friendly social sites get the lesson out:

stay in your place or suffer the consequences.

The means may change but the objective stays the same.

[What was Jim Crow?, Jim Crow Museum of Racist Memorabilia]


Who signs up for 7-Eleven wage slavery and sharecropping in 2015?

November 2, 2010

No new immigrant to Australia or the United States does. Or Canada.

Nobody does it intentionally.

They think it is impossible in a free society for modern day sharecropping to thrive in plain sight.

They learn, partially and too late, that the business risks are deeper and wider than they could ever imagine. Before WikiFranchise.org, no one has inventoried these investment risks. They blame themselves, miss the patterns and like in all well-structured con games 50% of the marks are good for a 2nd go.

He has the experience without the understanding. T.S. Eliot

— Thanks to ShawnBlog.com


Litigation group: Lawyer-led franchisee groups

August 2, 2009

TreasureChestI’ d like to discuss  an email I recieved this week.

Seems a Canadian restaurant franchise system (30 stores) is trying to organize themselves. I was emailed with the information that there is a meeting happening in 2 weeks and was wondering if I wanted to attend?

In a word: no.

The clincher was that the franchisee’s lawyer was “helping” them organize themselves, presumably under the pretense of affecting “change”.

The only change is usually what is left once the hat is passed to build a “war chest”.

I tend to leave these types of groups well enough alone.

The professional is most-likely creating a litigation group (a fundraising mechanism for a lawsuit) rather than a sustainable franchisee group like an IndFA, let along an Attorneyless Franchisee Network, AFN that harnesses the exponential group power in something like a buying group.

I sent along some links to this very nice lady that should show a +10 year history of predatory franchisor actions by her head office and that I knew what I was talking about.

  • Very few lawyers choose to work with me.
  • In 10 years of being available to help franchisee groups, make that 3 different ones.
  • I develop the case. Deliver it in a bow and soon: Thanks but “why is Les still around?”.

Maybe read what Canadian-born law and economics professor Gillian K. Hadfield has to say about the business of law before you hop into a much more difficult credence good relationship (than a franchisee:franchisor one)?

I wish the restaurant group all the best but I would suggest that they also write out their own narratives and consider submitting them to WikiFranchise.org. At least they could do is to send up a signal to the next wave of investors.

I tend to leave the door open but have learned to ask for payment in advance for 2nd opinions.

Really nice people in difficult times tend to choose the wrong people to trust.

I know. I did.


Cause of franchise deaths: usually 1,000 cash cuts

May 29, 2009

Death1000cutsThe cause of a franchise death is often viewed too simplistically.

There is very seldom one reason for a small business failure.

With franchising, the complexity and lack of control results in a fundamentally higher level of business risk (see WikidFranchise.org section, The Marriage of Franchising).

After having read hundreds of news articles, talked and interviewed nearly as many franchisees, you come to appreciate that a single franchise failure has certain similar elements but very many very common issues.

A new franchisee’s cash position is quickly weakened by hidden profit “bleeds” (high margins on supply, leases, equipment, leaseholds and tied/forced buying, contracting, etc.) that were not expected or budgeted for.

Sales don’t show up nearly as quickly or inexpensively as was planned on.

Reserves quickly dwindle, leaving the organism of your franchise vulnerable to a “fatal” adverse business incident. This culminating incident might be what you see as your franchisor’s bright idea, such as Tim Hortons’ frozen food centralized commissary decision. The extra 3 or 4% on COGS is too much for some marginal stores: Most simply slip away, largely unnoticed.

Some decide to fight with a $2-billion lawsuit against a Canadian “blue chip” system.

  • The latest cut (which has asymmetrical payoffs: ee v. or) is simply the straw that broke the camel’s back.

The franchisors’ means for extracting wealth from franchisees (acting opportunistically: self-interest with deceit) are so many that many smart investors have concluded that business franchising is unsafe at any brand.


Sue the Leafs/NHL cartel in eMcKangaroo Court

May 10, 2009

nhlTorontoMapleLeafsThe law creates just outcomes only in some cases.

In franchise law, the justice is delivered to those that control access to the Courts and the political process. Only franchisors and large franchisees have that clout.

The latest proof of this policy and law bias, is that the NHL and the Toronto Maple Leafs should be sued in an Ontario Superior Court for their unfair dealings, racketeering and extortion activities.

That won’t happen because franchising and especially sports franchising is a monopoly game played by insider credence good cheaters.

But: Why not try the bastards in a virtual Court room? I propose a McKangaroo Court to ease our pain. A mock trial for a phony form of competition (ie. sports franchises).

Hockey Maniacs: In southern Ontario, pro hockey is a God. The Toronto Maple Leafs have been able to sell out every game for over 40 years by providing, at best, a fitfully mediocre product (eg. a competitive sports team). Think of the Big Auto before Toyota and Honda showed up.

The Leafs owner’s are monopoly players in the world’s most lucrative hockey market. A normal fan can only dream of attending a game with their kids anymore.

Jim Balsillie has been trying to bring another professional hockey team to southern Ontario for some time now. His most recent attempt is to offer over $200 million to rescue the Chapter 11 Phoenix Coyotes and move them to southern Ontario, Canada.

But other 30 NHL owners (franchisees acting like franchisors, 25 which are U.S.-based cartel) have other ideas. And the encroachment  kickback to the Leafs and Buffalo Sabres is extortion: plain and simple.

The Globe and Mail reports on legal action, taken by the current owner of the Phoenix Coyotes in an article, NHL acting like ‘illegal cartel’, Coyotes charge:

“The NHL is excluding competition and restraining trade in [the United States and Canada] through the application of unreasonable restrictions in its constitution and bylaws, which are preventing the relocation of the Coyotes from Phoenix, Ariz., to Hamilton, Ont.,” said the lawsuit filed yesterday in Phoenix.

The suit also takes aim at Maple Leaf Sports and Entertainment [MLSE], which owns the Toronto Maple Leafs, alleging it has colluded with the league for years to preserve “market power” in the Greater Toronto Area. Prohibiting relocation deprives hockey fans of “increased competition, lower prices, higher quality and more variety,” the suit alleged. WikidFranchise.org citation

Remember: monopolies are “bad” because they creates market inefficiencies and distortions that are manifested in these very real and pernicious anti-competitive practices:

  1. Predatory pricing,
  2. Tied buying,
  3. Short- or forced-shipping,
  4. Encroachment,
  5. Economic conspiracy and
  6. Refusal to deal and exclusive dealing.

Alan Eagleson a disbarred agent/NHL power broker is THE poster boy for all credence good experts to this very long-suffering Leafs fan.  Wikipedia, WikiFranchise.org

Argument: The Arthur Wishart Act (Franchise Disclosure), 2000 governs all franchise commercial relations in Ontario, Canada.

  1. MLSE is acting as a “franchisor’s associate” under Section 1.1 (“franchisor’s associate, a. and b.).
  2. As a “franchisor’s associate”, Wishart treats MLSE is treated as if it were the franchisor (the same duties and responsibilities as the “normal” franchisor, in this case, the NHL).
  3. Section 3 creates an obligation by all parties:  “a duty of fair dealing in its performance and enforcement.”

I think the citizens of southern Ontario deserve to have their pro hockey fix met by the appropriate franchising corporations.

The Maple Leafs and the NHL  show their contempt for their real customers (ticket holders) by continuing to run their robber baron scam. For these offenses, they deserve to be sued.

And I bet there some CDN hockey nut franchise legal beagles that’d love to write up the arguments.

In this way, the problems that non-billionaire business format franchisees endure can be explained to the public while showing where the real weasels live.


Does Big Franchising at least legitimize The Big Con?

September 7, 2008

I have been reading a neat book called The Big Con: The Story of the Confidence Man by a dead American linguistics professor called David Warren Maurer.

This is what Wikipedia has to say that is catching my eye:

Maurer spent his career recording the argot of moonshiners and pickpockets, but The Big Con is his masterwork. …The Big Con reeks of 10,000 conversations in poolrooms and Pullman cars; its sentences ring with the raffish patois of ’20s and ’30s Americans on the move. “I’d sooner be a lamster any day than be tied up to a lop-eared mark,” grouses one sharpie stuck with simpleminded prey.

While working on his magnum opus, Maurer won the trust of hundreds of swindlers, who let him in on not simply their language, but their folk-ways and the astonishing complex and elaborate schemes whereby unsuspecting marks, hooked by their own greed and dishonesty, were “taken off” – i.e. cheated – of thousands upon thousands of dollars. The products of amazing ingenuity, crack timing, and attention to every last detail, these “big cons” richly deserve Maurer’s description as “the most effective swindling device which man has ever invented.”. The Big Con is a treasure trove of American lingo (the write, the rag, the payoff, ropers, shills, the cold poke, the convincer, to put on the send) and indelible characters (Yellow Kid Weil, Barney the Patch, the Seldom Seen Kid, Limehouse Chappie, Larry the Lug). It served as the source for the Oscar-winning film The Sting and will delight fans of such writers as David Mamet, Jim Thompson, Elmore Leonard, and William Burroughs for its droll, utterly authoritative look at the timeless pursuit of relieving one’s fellow man on his surplus cash.

And an except of a book review from the Mad Professor:

If you’ve seen The Sting, then you have the basic idea of how a big con works. It’s basically a theatrical production with elaborate sets and costumed actors for an audience of one. But the audience member thinks the production is real, and ends up losing his life savings by the time the curtain closes. The two most surprising things I learned from reading this book: one, the con men, who work so hard to set up a con and take the mark’s money, usually blow their cut immediately by gambling it away, and two, the victims of cons often return to the con men to get fleeced again, even when they know they were conned the first time.

To me, the second point is crucial: Maurer says the swindlers tell him that over 50% of victims get taken at least 2 times. Many get taken several times…by the same play [versions of the big con].

Another review which ends with the following question:

…where is the big con today?

Fueled with SBA or other easy credit, almost anyone can be roped into the next half-assed, unproven franchise scheme. They don’t just take your current dough and leave you with a warm feeling for the inside man, they take your future life savings, labour and often your health. And your spouse’s too.

  • You end up broke, gagged, shamed and most dangerous of all, unaware of how to learn from these experiences.

Big Franchising acts [alone or as a tag team: see Australia lawmaking] to protect their legitimate business interests which is fair in a market-driven democracy. But by doing so, they create a legal  and political influence umbrella that nourishes a commercial cancer called mom and pop franchise opportunism.

Economics classifies this out-of-control negative growth (cancer) an externality,


Credence Goods attract Experts who Cheat

August 27, 2008

If I had to choose the second concept that was critical to know in the study of franchising, it would be This one.

Lionel Hutz

HINT: If they’re talking about protecting franchisees and not talking about credence goods, they’re all hat and no cattle [all show and no go].

Some goods and services, by their very nature, come with much higher risks than others. These risks can be compounded and therefore astronomically high if:

  • there are few experts to choose from in a market,
  • the costs of switching experts is very high,
  • this is the first time you have contracted for these expert services, and
  • the experts organize themselves to protect one another.

As we shall see, franchising has compounded, interdependent and very aggressive expert stakeholders [see Big Franchising: franchisors, franchise bar, lenders, sales agents, consultants, politicians, media, etc].

  • As a franchise investor, you are at a severe disadvantage because of credence good service providers.

A Credence good is a good or services with the following 3 characteristics:

  1. the value is difficult or impossible for the buyer to determine accurately before they buy it,
  2. the buyer can’t know if it was useful [even after they did buy it] and
  3. also, the seller does know the value of #1 and #2 [could therefore exploit this ignorance for their own self-interest: information asymmetry leads to opportunism risk]. Wikipedia

Uwe Dulleck and Rudolf Kerschbamer:

Consumers’ concerns about being defrauded seem not to be unfounded: Emons (1997) cites a Swiss study reporting that the average person’s probability of receiving one of seven major surgical interventions is one third that of a physician or a member of a physician’s family. Wolinsky (1993, 1995) refers to a survey conducted by the Department of Transportation estimating that more than half of auto repairs are unnecessary…These examples reveal that infomational asymmetry matters. Free download: On Doctors, Mechanics and Computer Specialists – The Economics of Credence Goods

Gillian K. Hadfield, University of Southern California:

Economists refer to a good as a credence good if it is provided by an expert who also determines the buyer’s needs. Buyers of credence goods are unable to assess how much of the good or service they in fact need; nor can they assess whether or not the service was performed or how well. This puts buyers at risk of opportunistic behavior on the part of sellers: they may be sold too much of a service or billed for services not performed or performed poorly. Theoretical work on markets for credence goods predicts that markets for credence goods may be characterized by fraud (billing for unnecessary services or services not performed) and a price mark-up over cost…Legal services are credence goods… Free download: The Price of Law: How the Market for Lawyers Distorts the Justice System

Winand Emons, University of Bern:

With a credence good, consumers are never sure about the extent of the good that they actually need. Experts such as doctors and lawyers, as well as auto mechanics and appliance service-persons (the sellers) not only provide the services, but also act as the expert in determining the customer’s requirements. This information asymmetry between buyers and the seller creates strong incentives for the seller to cheat. Free dowload: Credence Good Monopolists

We will come back to credence goods and how these types of services really help value being stripped from investors with deceit [opportunism].


Big Franchising

July 18, 2008

Most small business investors define franchising in an inaccurate and childlike way.Everyone knows McDonald’s and that it has made many franchisees millionaires.

McDonald’s is a franchise and so all businesses that are franchised must be a success. Maybe the relationship is not 100% causal but it’s a close relationship. Right?

Wrong!!

We Deceive Ourselves: We notice the flashy new sub sandwich shop or the prestigious dog poop scooping service trucks. We always wanted to go out on our own but didn’t want to risk too much. Franchising is pre-sold as a less risky alternative.

We think we might like to look into buying a franchise and this one seems pretty good, so far. Unconsciously we have started down the road in remembering information that would support a yes decision but also ignoring any negative data [confirmation bias].

Humans tend to over-rely on the physical, on what you can see, hear and touch. That evolutionary predisposition has worked well for thousands of years but in a complex, commercial setting spanning international corporations, our “lizard brain” is not too well equipped to deliver a good decision.

 

WHAT IS BIG FRANCHISING?

Little franchising is what you can see [the branches, leaves of the tree]. Big Franchising is what you can see plus the invisible organizations that feed and nourish the organism [the roots].

  • As the son of a farmer’s daughter, lawn care operator and retired agronomist, I know that 90% of the weight of a plant is underground. The power and danger of franchising is hidden.

Relationship: the first factual error that the power dynamics are simple; that they are limited between the franchisor and the franchisee. The unwary pre-sale or unaware ex-franchisee believe that it is fairly simple David and Goliath story and that this individual franchisor is either a “good guy” or a “bad guy“.

Nothing could be further from the truth.

Public Policy: the true face of Big Franchising is revealed when you watch closely what happens when a law is proposed. Most of the aligned interests prefer the shadows and only come into the light when their favoured positions are threatened.

Big Franchising: Expert specialists

Definition: an informal understanding between legally independent corporations and organizations that serves their mutual commercial, power and political interests.

Members & Role

1. Product franchisors: The Big 3 [Auto, Grocery & Oil] but also very large corporate concerns such as Coca-Cola. Massive, aggressive and willing to get on the phone and bully any politician into the middle of next week.

2. Business-format franchisors: The Blue Chippers [McDonald’s, getting fewer and fewer]. Largely co-ordinated through the national peak trade association [ie. AU National Franchise Association, Kiwi Franchise Association of New Zealand, Canadian Franchise Association or the U.S. International Franchise Association. or their subservient members and the other [usually] 80 to 85% of franchisors who do not belong to the national franchisor association. These are public apologists and training centres for franchisor opportunism.

3. Franchise Bar: The very few large international law firms that have a very lucrative franchise specialty and other boutique practices. A useless law to investors [McLaw} is a great law for The Bar because of the irrelevant, but seriously misleading disclosure documents that need to be written. This is a very protective group of extremely sensitive businesspeople who happen to discuss law in their spare time.

Any lawyer hoping to join the club better play by the rules. Rule Number 1 is serve Big Franchising who arranges to pay 95% of all legal fees. You can usually find the majority of the Franchise bar in the national franchisor association’s membership lists. [Australia, New Zealand, Canada]

Franchisee clients are thought of as a means to pay the rent until you can do some serious billing to the franchisors. When I was in high school, certain girls were considered practice girl friends. I believe I don’t have to go into too much detail here. The high school male and the struggling franchisee lawyer have the same thing in mind.

Each country has a King Rat franchisor lawyer. His job is to discipline the Big Franchising members and instill fear in dissenting opinions. I could name the U.S., Canadian and Oz/Kiwi guys but I promised my wife, no more lawsuits.

4. International peak association: the World Franchise Council is an information sharing project for Big Franchising. It provides training in keeping each nation’s public asleep to the true nature of franchising [higher risk, rent not own business, churning, on and on]. It keeps all their members aware of the defenses available to thie members: The “How-to” of defeating all franchise investors’ claims.

Responds to Oz’s public understanding is a babe in the woods when compared to the U.S. and Canada. The U.K. are still in Big Franchising’s womb, largely because of a very docile business media.

5. Financial Institutions: franchising is extremely lucrative for lenders and financial service providers. National programs are set up that kick back millions of franchisees’ dollars every year to franchisors. Lenders often will disregard the law when they fake their lender’s due diligence duties. They often engage in a cluster of behaviors I have defined as Predatory franchise lending. [Australia, New Zealand, Canada]

6. Product suppliers: franchised businesses are higher margin customers. The franchisor negotiates their kickbacks and the franchisee is forced to pay the inflated price. This is really an undisclosed add-on franchisee fee [often, at least, doubling what you thought you would be paying]. Here is an example: A franchisee paying more for shipping [franchisor] than he did for rent [no head lease].

7. Salespeople: these charming individuals call themeelves consultants, business brokers or researchers. Some even hide behind their PhDs. They steer you to those systems who pay them for for their ability to invoke your trust. Don’t be fooled: Almost 100% of the time, they don’t get paid until you say yes and only from the franchise system that they get paid a commission from. They may charge you a few thousand bucks to find the “right fit” but the real dough will flow when the trap snaps shut [sign the franchise agreement or loan papers]. [Australia, New Zealand, Canada]

8. Media: this is the more subtle one. Experienced journalists know all the sordid details of franchising and have known them for many years. Editors do not publish stories that interfere with the commercial interests of their bosses which are in the same Big Franchising club. Occasionally, stories are published but they are simple open-and-shut cases that would never give the public an idea that the problems are systemic [affecting all parts] rather than individualistic [blame the victim]. The lies the media tell are told in silence.

9. Politicians/Regulators: politics is the brokering of competing interests. Big Franchising represents some of the world’s biggest corporations.

Politicians and regulators know their career is short and corporations’ memories are long. The practice of law has almost entirely been taken over with corporate interests. The widespread use of compulsory private law contract provisions [arbitration and mediation] hides the industry’s abuse.

Franchisees are unorganized mom-and-pop shops, mostly. People that think that even national inquiries will discover the truth and then the truth will will result in a good law [reflects reality] are hopelessly naive about how power works.

10. Miscellaneous: this category includes academics, especially [with some notable Oz exceptions] those pesky consulting fee-dependent business administration professors, Trustees in Bankruptcy, equipment and business appraisers, mediators, arbitrators, non-franchise bar law firms, financial services ombudsmen [apologists for predatory lending practices], national privacy commissioners, law societies [very attentive listeners to large law firms’ economic concerns].

Summary: There exists a complex web of invisible but very real relationships that created, supports and aggressively defends the franchise industry’s dominant power structure [status quo].

  • All things being equal: You may be profitable or achieve your financial goals.
  • But, all things are not equal in franchising, are they?

Ignorance of your potential adversary’s power and influence is no excuse. At least for those with ears to hear.


%d bloggers like this: