Why do franchisees stay in a money-losing venture 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.


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