Even in the best of times, franchisors of everything from
restaurants to muffler shops have little insight into how well or
how poorly their franchisees are doing. But in a downturn, the
risks of working in the dark are multiplied: There can be a
cumulative effect as franchisees across the network struggle for
survival. Franchise failures can hurt the brand, scare off
potential new franchisees and end up in costly litigation. For
their part, franchisees may worry that their franchises could be
pulled if they get behind in royalty payments. Based on our
experience, both parties opt to ignore the possibility of
franchisee distress until it's too late.
In addition to not knowing fundamentals such as the health of
the franchisee's operations, their cash situation or the strength
of their balance sheet, franchisors don't know when a franchisee
who appeals for help really needs it. Some franchisees approach the
franchisor for help long before making tough choices such as
reducing their owner distributions or closing underperforming
operations. Harder still for the franchisor is determining whether
operations improvements or royalty relief will be enough to help
Consider the situation facing one major franchisor. The company
knew that many of its franchisees were in trouble-60 percent were
either not paying royalties or were asking for relief. Because of
legal responsibilities to treat all franchisees equally, the
franchisor could not just pick and choose where to provide
assistance. What the franchisor needed, before taking any action,
was a clear view into the seriousness of each franchisee's
situation. Only then could the franchisor determine which requests
for royalty relief were legitimate.
Bain & Company worked with the brand to take a proactive
approach-one that helps both franchisors and franchisees gauge
their situation and identify opportunities to improve performance
in good times and bad. By conducting a detailed assessment of the
financial and operational health of its franchisees, the franchisor
discovered a startling statistic: 30 percent to 40 percent of its
franchisees were at risk of default within a year, a situation that
had a potentially significant impact on the viability of the brand.
Recent Bain experience suggests the brand is not alone.
For franchisors whose revenues have declined during the
downturn, we have observed that between 20 and 50 percent of their
franchisees could be in financial distress.
Why do it?
A franchise health check-up, performed with the full
participation of franchisees, provides a holistic view of
everything from operating metrics to capital structure. One company
that recently conducted such a check-up was able to help almost all
of its at-risk franchisees develop strategies to weather the storm.
Despite franchisees' requests for relief that totaled many millions
of dollars, the franchisor invested less than 5 percent of that sum
to save almost all of its troubled franchises.
One of the key success factors of a franchise health checkup is
that, when done cooperatively, it deepens a franchisor's
relationship with franchisees. Also, the analysis helps identify
opportunities where a franchisee could improve operations. In one
meeting, a restaurant franchisor determined it could help a
franchise improve its margin by 2 percent overnight through a
simple change in how it ordered its poultry. That level of insight
is not something franchisors can typically provide when they know
only the revenue performance of the business. A check-up also
uncovers the challenges franchises face due to their cash positions
or capital structures, bringing a rigor that all but the most
sophisticated franchisees are not able to bring on their own. We've
found that most franchisees feel that going through the process
helps better align the interests of both sides and that the
franchisor better understands their situation.
Another practical benefit of a franchise health check-up is that
it enables a franchisor to evaluate whether financial assistance is
needed. In our experience, franchisees who ask for relief can
typically be segmented into three groups:
- Those who either don't need it or can be helped with operations
- Those who need help, but for whom relief alone won't be enough
to avoid default over the long term due to misaligned capital
structures. These franchisees should be encouraged to develop a
plan to restructure their debt.
- Those who cannot be saved and are likely to lose control in
bankruptcy or face liquidation. The franchisor should demonstrate
the seriousness of their situation, and encourage them to develop
an exit strategy to minimize the impact on their own financial
Helping franchisees shape up
Bain has developed a three-step process for maintaining the
health of a franchise brand.
1) Conduct an annual holistic check-up.
Franchise operations work best when both franchisors and
franchisees work collaboratively for their common benefit.
Franchisors can encourage franchisees to take part in such a
check-up as a requirement for participation in any current or
future royalty abatement programs.
A holistic check-up should look at a franchise's capital
structure, cash flow and other indications that it could be at risk
of default. For example, a check-up could evaluate contingent
liabilities that might be draining a franchisee's finances in tough
times. It's not uncommon for a franchisee to use the cash flow from
one successful business to fund troubled holdings.
2) Prioritize your investments. Franchisors
seldom are able to satisfy all the requests for financial
assistance from franchisees, nor should they. Franchisors need to
make hard choices about how to invest their limited funds to have
the most impact while treating all franchisees with equal
consideration. That means prioritizing investments based on the
depth of need and the potential impact on the network.
3) Design a playbook to improve network health.
Franchisors need a decision-making framework for taking action that
reflects both franchisor and franchisee priorities, including
guidelines that ensure that any actions taken by the franchisor
represent fair and equal treatment. In one case, a franchisor is
using its new understanding of each franchisee's cost structure to
identify the level of same store sales performance at which each
franchisee is likely to encounter trouble. By monitoring each
franchise's revenue, the franchisor can proactively identify and
respond to any risk of distress.
This three-step approach has helped franchisors overcome serious
threats to the health of their network. Empowered with information,
they can better prioritize resources and collaborate with
franchisees. Some franchisors have used this as a basis for
transforming their approach to working with franchisees-not just to
stem the risk of default but also to position the healthiest
franchises to grow at their full potential as the economy
Sidebar: Signs your network could be in
- Falling same-store sales for franchises
- Declining franchise revenues due to store closures
- Concentration of more than 30% of the brand's franchise outlets
in the hands of relatively few franchisees
- Rising requests from franchisees for royalty relief or other
- Sale-leaseback transactions among your franchisees between 2004
- Franchisee exposure to risk from their other holdings
- Franchisees grappling with capital structure issues
Key contacts in Bain's Global Retail industry practice
North America: Neil Cherry in San Francisco, David Sweig in
Chicago and Eric Anderson in San Francisco