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,

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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.


Hadfield on Opportunism

July 17, 2008

Gillian K. Hadfield wrote Problematic Relations: Franchising and the Law of Incomplete Contracts in 1990. It remains the gold standard of defining why franchising remains such a difficult area for the law to deal with.

See here’s the rub: Franchisors legitimately require discretion because no contract could ever be written that would exactly specify, to the penny over many years, through market changes what each party will do. That’s fair.

What is not fair is when a franchisor exercises his discretionary powers in a way to strip a franchisee’s [and their family’s, usually] labour, life savings, credit worthiness and future earnings. This is possible largely because the investment is trapped [sunk cost] and dependent on the franchisor’s whim.

The Problem for the Law: Did a franchisor have a legitimate business reason for doing what it did OR is it just acting as a predator? This is what judges have a hard time dealing with.

You can can download a copy here.

Hadfield’s 2000 expert testimony to the Ontario government is also presented here. She presents an excellent judicial test for opportunism and I got to help with the overhead projector.

  • Opportunism fueled by sunk costs: the most important and distinguishing characteristic of franchising. If you aren’t talking about opportunism, you are wasting your time.

A very useful thumbnail sketch of Problematic Relations is provided by Michael Webster here. The franchisors problem is quality control but that is fairly easily solved.

The franchisee’s concern is defending against opportunism.

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.

It is this point: franchisees will continue operating a losing business [long past the time an independent business would have abandoned it] because of their sunk costs.

 


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