On the one hand, franchise brands will be more likely to improve supply chain relationships and organise marketing campaigns to attract customers to their outlets away from unbranded independent small businesses which have been kept afloat by unsustainably high consumer demand.

On the other hand, franchises are also likely to suffer a softening of demand (though not as much as their unbranded independent small business counterparts), which could well mean that turnover and/or profitability will reduce. In response to declining turnover or reduced profits, franchisees (and small business owners in general) can be expected variously to offer discounts, and cut costs by reducing labour and other costs including the cost of goods through the use of substitute goods or inputs. Cashflow may also come under pressure and with this comes the juggling of creditors, including the franchisor, who may find franchisees falling behind in their royalty payments.

This in turn can cause problems for the franchisor, and therefore the franchise brand as a whole.

Firstly, for those systems whose royalties are determined as a percentage of a franchisee’s turnover, revenue to the franchisor will also decrease if average franchisee turnover also decreases. Franchisors have fewer “products” to sell than their franchisees. Their income is limited to royalties, mark-ups on product or services supplied to franchisees, and the sale of franchises. Consequently the franchisor’s ability to discount is limited (and less effective in stimulating demand) and with its own profitability coming under pressure, the franchisor is also likely to look at reducing costs, much of which will come from the provision of franchisee support.

In particular, travel budgets will come under tighter scrutiny, potentially reducing the frequency of in-person field visits to franchisees located remotely from the national office, and putting further emphasis on lower-cost support methods via phone, webcam, email and online. Franchise support personnel may also be cut or otherwise reduced via natural attrition, resulting in a widening ratio of franchisees per support person, and putting existing support personnel under greater pressure to deliver more with less.

In-house property, legal, marketing, supply, IT, construction and even recruitment departments may also be reviewed, reduced or even outsourced in the pursuit of improved cost efficiencies at franchisor head office.

Of course for those franchisors with a flat-fee royalty, where the franchisee pays a preset amount per week or month, the current economic turmoil will have less of an impact on their overall turnover, but will potentially result in greater delinquency by franchisees in paying their royalties on time (if at all). Indeed franchisee delinquency is likely to be a growing problem for both fixed-fee and percentage-of-turnover franchisors, resulting in an increase in monitoring costs.

Even those franchisors who have both a fixed minimum fee topped-up by a variable fee over a certain threshold will still find their monitoring costs increase while their royalties decrease (though not so much as the percentage-of-turnover-only systems).

The potential reduction in franchisees’ turnover becomes a double whammy by reducing the contributions (usually also paid as a percentage of turnover) available for a system’s marketing efforts (which is one of the key things that provides a franchise with advantages over independent small businesses).

To maintain profits for itself, the franchisor may be forced to reduce its reliance on royalty income from its franchisees. This could mean increasing the mark-ups on any goods or services provided to franchisees (or the rebates paid to the franchisor where goods or services may be provided by a third party). Alternatively, it could also mean selling more franchises at a time when more people are losing their jobs and willing to consider buying a franchise to create employment for themselves.

Franchisors have frequently bemoaned the lack of franchisees in recent years during the buoyant jobs market where workers could almost name their price and employers would fall to their knees in gratitude that someone would want to work for them. In such an environment, the rewards of small business struggled to compete with the allure of the next high-paying job, and very few people were prepared to consider starting their own business.

Today the situation has changed, and as the economy continues to shed jobs over the coming months, more people will look toward to franchising to provide them with the opportunity to be self-employed.

Unfortunately, unless the franchise brands to which these potential franchisees are attracted have strong cash reserves, they are likely to be contemplating (or already commenced) some of the cost-cutting measures outline above. The potential result will be an increase of franchisees in systems where support is being pared back or outsourced. The incoming franchisees may join at the very time where their cash injection provides the franchisor with the necessary means to survive, while at the same time the support provided by the franchisor could be less than that provided for earlier franchisees, resulting in an overall drop in the value proposition of buying the franchisee (from a franchisee’s perspective).

The key for both franchisors and franchisees in this scenario is to be discerning about what might be cut or changed, when, where, why and how, and what effect such cuts or changes might have on the long-term viability of the businesses of both parties. The interdependent nature of successful franchise relationships suggests that all good (and bad) things in moderation will provide the best overall outcomes.

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.

Copyright © Jason Gehrke, 2009.