What happens when franchisees turn off the Cash Flow tap?

February 19, 2009

tapI do not know, precisely.

But the greatest “winners” may very well be those that  turn it hard off, immediately.

I think anyone with any skin in the franchise game should be re-thinking their assumptions very carefully, right now. With their peers and with a commercial lawyer.

I wrote over at Blue MauMau that I thought franchising was undergoing a crisis of confidence. FuwaFuwaUsagi seems to agree.

This distrust is really different in four ways:

  1. it is for all franchises (not Brand A or Brand B),
  2. systemic (affects all brands),
  3. cataclysmic (most systems underwater in one year?)  and
  4. it is from the franchisor’s lending associates (not franchisees).

This is fundamentally different than in any other time in franchising’s history. Pay attention.

How an Industry Adapts into Into It’s Own Destruction

Unfettered capitalism is exceptionally efficient in allocating resources, maximizing ROI. But capitalism has some very nasty byproducts (externality: spillover costs). Fraud is a well-known example of an externality that markets, alone, cannot correct for. We are seeing now the carnage of short-term only incentives. Totally predictable, totally understandable.

1. Once upon a time, franchisors acted responsibly and achieved an adequate return on investment, ROI. They invested in real industries with competent managers and franchisee partners. Col. Sanders, Ray Kroc.

2. A franchisors decided to cheat. They pushed the opportunistic envelope by treating slaughtering instead of shearing investors. They made a higher ROI than the less sharp franchisors because it is always more profitable to steal than to earn money.

3. A sophisticated understanding, “conspiracy”, cabal was knit together with the franchise bar, suppliers, lenders, regulators, and the media (Big Franchising). There is never any reason to write down anything: each independent party is simply acting in their self-interest by peddling these false franchises. Of course, short-cyclers always cut the apple trees down for firewood instead of caring into the long-term.

4. The public still believed that franchising was Ok but with a few rotten apples. Over time, though, greater doubts were raised even though the information monopoly still was holding.

5. The influence of the few innovator franchisors and Big Franchising grew and grew.  It was going very, very well: no one suspected a thing and the sheep were as docile as anything. Only the chumps didn’t adapt by becoming tyrants themselves. Everyone made out like bandits that was wise to what became more and more to resemble a confidence game or ponzi scheme.

6. Then came the internet and lower-cost sharing of information. This would be technological revolution that not change but destroy the credence good monopolists’ power.

It’s over because their own greed and hubris will result in wholesale investor defections lead by non-franchise bar solicitors.

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Madoff investor takes own life

December 24, 2008

reneI know very little about hedge funds and how they are managed.

I do, however,  have some experience in dealing with people who are confused, suffering from temporary distorted thinking and have had their confidence in themselves profoundly shaken.

Fraud is primarily a violent attack on the victim’s identity and his core belief in the predictability, if not fairness, of his world. No one I have known lists economic loss as even a minor consideration, if they come out of the valley. Excuse me for  suspending  judgment as I remember those that didn’t make it out of franchising alive.

The New York Times reports that Mr. Rene-Thierry Magon de las Villehuchet, founder and CEO of hedge fund Access International Advisors, LLC, was found dead yesterday. It appears that that the fund has about $1.4-billion exposure in the Bernard Madoff affair.

I do not know precisely the pain that drove who appears to be an extremely sophisticated, successful and dignified individual to commit suicide. If the coverage in The Toronto Star is any indication, he presented as one classy person.

  • Beyond that, I have no right to judge anyone else.

Maybe he felt he had committed an unforgivable error by trusting Madoff? That he subscribed to the belief that “To those whom much is given, Much is expected“? Maybe he felt if he was smarter, worked harder, paid more direct attention he could have prevented this loss? Maybe it’s just random, there is no connection at all: It’s just the media picking up on mob’s cries for “some rich elitist bastard to pay” (regurgitation of Storming of the Bastille, off with his head).

  • Who knows? Only time will tell but that story carries its own biases.

Galbraith‘s The Great Crash 1929, however asserts quite strongly that the incidence of suicide did NOT increase because of Wall Street’s collapse:

In the United States the suicide wave that followed the stock market crash is also part of the legend of 1929. In fact, there was none.  p. 131

I suspect that time and hindsight will reveal that Madoff’s alleged (in quotes) “ponzi scheme” was business as usual in today’s perverted form of casino capitalism (eg. the only difference is that this sausage exploded; hundreds of other fraud sausages happily robbing Peter to pay Paul).

What I do know, is that his family will miss him and that this loss sucks at this time of year. I’ve lost way too many people in December.

When everything’s black, let’s hope that each of us has at least one person to talk to.

  • Let’s keep in touch with each other, ok?

Franchisees catch pneumonia when a franchisor gets a cold

June 18, 2008

Sometimes franchisees inherit problems that they had nothing at all to do with. Sometimes those complex, uncontrollable issues are toxic enough to kill their already weakened business.

A couple of articles from South Africa caught my eye this week.

And as usual, the immediate issue was not the the full story. You have to know what questions to ask to find out where the bodies are buried.

The problem was initially defined in a June 13th article as a dispute between the franchisor and a DVD distributor: DVD stores face legal action after ruling

Video and DVD rental stores across South Africa may face legal action if they are found contravening copyright laws, after the Cape High Court barred Mr Video and 22 of its franchises from renting DVDs not acquired through local authorised licensee Nu Metro.

It seems the franchisor made business decisions that other companies disagree with. In this case the adversaries (that the franchisees have inherited) are fairly substantial: Twentieth Century Fox Film Corporation, Disney Enterprises, and Warner Bros Entertainment.

These other companies have filed suit against the franchisor and the franchisees.

Attorney Anthony Norton, representing the studios and the distributor, said the rental outlets now face claims of damages by the major studios.

He said in some instances, the titles were released for rental by Mr Video before their theatrical release here.

As a franchisee you rely heavily on your franchisor. If a franchisor acts in a controversial way, you often suffer much more than they do.

A June 18th follow-up story paints that picture: Mr Video faces another legal wrangle

…some of its former franchisees who have accused the DVD rental company of “grossly unfair business practices”.

At least four former franchisees in KwaZulu-Natal have confirmed they were forced to close their shops because they could not pay their debts. Some have lost everything because their assets were attached to settle outstanding debts that ran up to R500 000 for each franchisee. The debts include bank loans and royalty fees.

Churning is a term that has been used in North America that describes a specific franchisor business behavior. The signs are:

  • New stores are opened with little regard for where, when or who (if they can “fog a mirror” and sign the loan papers — they’re in!).
  • Existing stores are sold, and then sold again, and then resold (often as quickly as every 12 months, sometimes less time).
  • The “promiscuous” (I’m being generous here) financing is largely through one lender and one loan officer. Potential owners are steered to them for almost instant approval which breaches the lender’s due diligence duty).
  • If the loans are underwritten by a government guarantee, this really acts to fuel the predatory fire.

Bank loans used to finance a franchise system that is alleged to be churning?

  1. Does South Africa have a small business loan program (ie. a high percentage of any defaulted small business loan is paid back to the lender)?
  2. Were any of these specific defaulted loans written under the program?
  3. Were the “bad” loans all with the same lender?

If the answer is “yes” to two of these questions or some similar red flags, then the likelihood of Predatory Franchise Lending should be looked into.

Some franchise systems operate like a Pyramid or Ponzi scheme. They were created to fail from Day 1:

  • the franchisor collects and hides as much cash as possible from the most unsophisticated investors available (sound familiar?) and then declares an intentional insolvency which leaves everyone with a claim against that specific company holding an empty bag.

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