Sunk Cost Reality: Post-signing relationship conversation

October 15, 2008

Franchisor to franchisee:

OR: Les the new poo-extraction technology will cost you $100.

EE: So the non-logoed dog poop scoop, in the real world, costs $5.00. Right?

OR: Right.

EE: But I have to buy this propriety equipment from you, right? [tied buying]

OR: Right.

EE: So I end up paying 20 times as much for the scoop, does that sum it up the situation?

OR; Yup.

EE: And if I don’t want to [as any sane independent businessperson would do]…?

OR: I can terminate you and refuse any potential buyers and other nonsense which deprives you of, say, 90% of the $100,000 you’ve sunk into your business. Sound fair, Les?

EE: So my decision is either:

  1. lose $95 by saying yes or
  2. lose $90,000 plus the exit costs by saying no. [Prospect Theory]

Is that a fair comment?

OR: Is that a fair comment, what?

EE: Is that a fair comment…sir?

OR: Yes, Les. You’re coming along.

Sunk costs as they compound business risk are a unique and little discussed aspect of franchising. Law makers are particularly negligent in not putting each post-signing franchisee buying decision in its appropriate context. Franchisees often look stupid in hindsight because sunk costs are not taken into account.

  • Context is everything in the bizarro world of a franchise relationship.
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Tied buying creates a Hidden franchise fee

August 8, 2008

This is an interesting article from Kiwi’s Sunday Star Times.

Journalist Greg Ninnesson reports in Marriage made in Hell for upset pizza franchisees that some of Hell Pizza’s franchisees are not pleased with the new mandatory supply arrangements.

No wonder: A monopoly is bad for the whole economy because it leads to inefficient allocation of capital and unjustified profitability [economic rent] based in deceit.

A meeting of several dozen franchisees held in February expressed dissatisfaction with the supply arrangements for their ingredients and other goods.

Previously, each franchisee bought ingredients such as flour, cheese, meat and vegetables directly from independent suppliers on a contract basis.

But in February, TPF set up its own supply and distribution operation and its outlets were required to buy most of their ingredients through that.

The franchisees were concerned about the transparency of the new supply arrangements and the effect it could have on rising food costs.

Maybe forming an independent franchisee association would be a good first step. But you better chip in a few $1,000 each [to start] for the best franchisee-only lawyer you can find.

  • Compare the cost to a 1% increase in your Cost of Goods per year. [You don’t honestly think this is the start of the blood-letting, do you?]

This is how I coded the article as it went into the Information Sharing Project:

  • Advertising fund put into general franchisor’s coffers,
  • Advertising fund use disagreements,
  • Franchisee revolt,
  • Franchisor owns more than one system (subsidizes loses from cash cow)
  • Gouging on supplies,
  • Monopoly,
  • Profits from one franchise system sucked out to subsidize another one,
  • Supply margins are a hidden added royalty payment,
  • Must buy only through franchisor (tied buying), and
  • Veil of secrecy.

Kickbacks, listing fees, volume discounts, co-op $, etc. are a beautiful thing to behold: If you are the franchisor.

  • Were you promised that volume buying through a franchise would actually save you money?

See the American Franchisee Association‘s, The Twelve Worst Franchise Agreement Provisions which include:

  • Sole Sourcing Requirements
  • Lack of Accountability of Advertising Fund
  • Kickbacks

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