Kleins, the Titanic, and lessons for us all

Franchisor failure is an unsavoury topic which participants in the sector rarely discuss publicly. But here goes. JASON GEHRKE

By Jason Gehrke

The collapse of Kleins and several other insolvencies of both small and large franchisors so far this year has thrown the issue of franchisor failure into a rarely illuminated spotlight.

Like a sinking ship, a franchisor failure often creates a suction that drags surviving franchisees down with it, leaving only a small amount of wreckage on the surface to identify that the system ever existed (such as a vacant store, a painted-over sign, or a Yellow Pages ad). But this flotsam associated with the tragedy of a system collapse is rarely visible years or even months after the event.

The Titanic, an “unsinkable” passenger liner which became one of the greatest maritime disasters ever, sank with its lights on and its engines running. Franchisors can also sink in a similar fashion. Up until just a few days ago, the website for Kleins was still touting the franchise’s virtues as a business opportunity.

In comparing franchisor failure with the sinking of the Titanic, there are some surprising similarities. Here are just two:

The myth of invulnerability

The Titanic was designed, built and promoted to be unsinkable, yet sank on its first encounter with an iceberg. Franchisors create for themselves an equal myth of unsinkability. A common appeal in almost all franchise recruitment advertising is that a system is “proven”, but rarely is there any substance to this claim. What exactly has been proven? How has it been proved? Who proved it? When?

The notion that a system is proven simply because it exists ignores the possibility that it may have been on life support from the outset, or is sailing directly into the path of an iceberg.

This myth of invulnerability is shared by both franchisors and franchisees. Franchisors, like any other entrepreneur, do not set out to go broke. Nor do franchisees, who buy into a system on the expectation that the brand, systems, marketing and support provided by the franchisor will substantially reduce their chance of failure compared to an independent operator.

However studies in both Britain and the US indicate that up to three out of four new franchisors will fail in their first 10 years*. These tracking studies, conducted independently of one another, both come up with roughly the same figure for franchisor failure.

My own preliminary research in Australia shows this figure to be closer to one in three franchisors here will fail in their first 10 years**, but more research is required to determine if the rate of franchisor failure overseas is reflected in the local market.

The myth of manoeuvrability

Like the myth of invulnerability, the myth of manoeuvrability originates with the franchisor. Prior to franchising, a business is often quite small and agile, and able to make changes rapidly to reflect a dynamic marketplace. In this regard, it is a bit like a jet ski – highly manoeuvrable, light, fast and responsive, but with only the driver and maybe a single passenger on board.

Even when franchising commences, a franchisor’s business may still feel like a highly manoeuvrable craft because of the rapid changes introduced to the system as it grows, but most of this perceived manoeuvrability will come from an increase in the size of the engine (due to the number of passengers on board), rather than any real improvement in steering or navigation abilities.

The more passengers (franchisees) the bigger the ship must become, until inevitability it loses the agility and manoeuvrability that made it successful in the first place. So now when travelling at speed, rather than comfortably steering around the iceberg, it may be impossible to prevent the ship from sailing into it, as with the Titanic all those years ago.

The myth of wealth

The Titanic was a luxury cruise liner which represented the best of everything on offer in the year it sailed. Many passengers were rich, or aspired to be rich by rubbing shoulders with rich people and doing the things rich people do. Those who weren’t rich were travelling to a better life across the sea, and had staked everything on a journey that would take them there.

Similarly franchisees aspire to a better life in the hope of wealth and prosperity through their investment in a franchise, and are often persuaded by the perceived success stories of others already “on board”. Many are not fully aware of the work and commitment involved in running a successful small business until they are already in, and the glamour of self-employment soon wears off when the reality of turning a profit kicks in.

Like passengers on a ship, there are few opportunities for franchisees to disembark once the journey has begun. They have little choice but to put blind faith in their captain and crew that the ship is heading in the right direction. For many the journey is truly worthwhile.

Both franchisors and franchisees should be aware from the outset that the journey is not without risk. No ship is unsinkable, and the bigger it becomes the more difficult it is to steer. Furthermore, icebergs and other risks can appear from anywhere at any time, and both franchisees and franchisors should maintain a constant watch and be prepared to act at the first sign of danger.

Had the Titanic and Kleins followed this advice, two tragedies could have been averted.

References:
* Stanworth, J, Purdy, D, English, W & Willems, J 2001, ‘Unravelling the Evidence on Franchise System Survivability’, Enterprise and Innovation Management Studies, Vol. 2, No. 1, pp.49-64.
* Shane, Scott A 2005, From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company, Prentice Hall, Upper Saddle River, NJ.
* Blair, D. Roger & Lafontaine, Francine 2005, The Economics of Franchising, Cambridge University Press, New York.
** Content analysis: Franchising and Own Your Own Business Magazine, vol. 9, no. 5, Advertiser Index p. 136, HH&M Media, Sydney.

 Read more on Kleins and franchising

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.

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Comments

Ray Borradale writes: This blog has certainly shaken a few trees and received the attention it deserved. I for one; and I am sure a lot of others in the franchising community would like to see more information on this topic. I have some questions and not necessarily for Jason. It is time that Government came clean.

In the US and in Britain we have up to three in four franchisors failing in the first 10 years of operation – one in three in Australia based on early data. I really don’t believe we should play down what these figures represent.

Consider the figures that Jason reports; up to 75% of franchisors in the US and Britain fail in the first 10 years of operation and most take with them a hell of a lot of franchisees. And this is from countries where there is considerably more transparency, and “research”, than there is in Australia. In Australia where no one is really looking, we come up with over 30% that fail and destroy the lives of hundreds of people, if not thousands. So it isn’t just the numbers of franchisors that should be of interest. What are the real numbers?

What are the real numbers of those who naively thought that franchising was regulated and the regulator had a couple of bucks and the backing of effective law?

And why do they fail? Some of these franchisors may have been unlucky, after all markets do change. Some might not have researched their franchise model well enough and those that bought in may not have done their homework either. But what about those get-rich-quick franchisors who designed systems to suck the life out of gullible franchisees knowing that such systems must have a short life span? In business your reputation is everything, and in franchising it catches up to where they cannot sell a franchise and those franchisees that fail cannot be replaced (doing considerable damage to the rest of the industry in the process).

These are just some of the numbers the Government should be interested in. What data can be captured from insolvency and bankruptcy agents and the tax office? How many suppliers, lenders, landlords were burnt in the process? The basis of the “early data” in Australia is flawed as are most of the conflicting figures released from time to time. “Based on their figures” the FCA reports very few complaints; but it forgot to tell anyone that it turns them away. The ACCC knows a little more, but it keeps it a secret knowing that thankfully the franchising community has slowly (too slowly for some) lost faith.

At least 87% of Australian franchisees in trouble don’t complain and so they don’t make it into most of the data. So what has this cost Australia and Australians – when no one was looking?