How failed growth expectations destroy credibility

The Byron Bay Cookie Company recently announced ambitious plans to expand to the United States and the United Kingdom, as well as to increase its number of stores in Australia.

Later that same week, the production company at the centre of the business was placed in the hands of administrators.

While administration in itself is not the kiss of death for a business – the process of administration can help nurse a business to good health – it does highlight that something was fundamentally wrong with the business model or management’s execution of that model for the business to go into administration in the first place.

Media reports at the time quoted one of the company’s directors as downplaying the administration by saying that it affected the production company only, but not the retail operations.

Perhaps it should be pointed out to the director concerned that under a distribution franchise model if the source of supply (i.e. the production company) ceases to operate, then the retail outlets have little or nothing to sell and can also expect to fold shortly thereafter.

Such was the case with the collapse of whitegoods retailer Kleenmaid in 2009. The company imported products from a variety of international manufacturers which it sold under its own brand through franchised commission stores. These stores were showrooms only and did not hold any stock.

Customers who bought items at a store would actually have them delivered and installed from a central facility operated and controlled by the franchisor. Only after the item had been installed would the retail store franchisee then receive their commission for the sale of the item.

When the Kleenmaid group of companies was placed into voluntary administration, its central distribution system collapsed, leaving the franchised retail stores without products to sell, and facing the wrath of thousands of customers who had paid more than $25 million in deposits for products that would never be delivered.

Similarly in 2008, the collapse of costume jewellery and accessory retailer Kleins, which was the sole supplier of products to the 130-plus retail stores in the network, led to the inevitable demise of the retail network which no longer had products to sell.

So for a director of any centrally supplied distribution franchise to downplay the importance of the insolvency of the central production and supply hub in the survival of a retail chain is breathtaking in its failure to comprehend the potential consequences of that insolvency.

Coupled with The Byron Bay Cookie Company’s extravagant claim of bold expansion plans earlier in the same week in which its production company is placed into administration, one can only ponder how the company’s management could reconcile its financial predicament with its stated aspirations, as the gulf between the two couldn’t have been greater.

Regrettably, the divide between reality and unrealistic ambition is often bridged by blind optimism – an admirable quality that often substitutes for any real talent or capability to achieve stated objectives.

There is no law against blind optimism, only its unsupported expression.

If, for example, a franchisor unreservedly claims that a franchisee will make a million dollars profit in their first year of operation, and on that basis a person buys a franchise and then fails to make the stated profit, then the buyer has a valid claim for false and misleading representation under the Competition and Consumer Act.

If, however, the franchise buyer is represented that 100 new outlets will be opened by Christmas, thus creating an impression of “buy now or miss out”, this alone may not be considered a breach of the Act if the buyer did not rely on the representation when committing to the transaction, not withstanding the hollowness of the claim if less than 100 outlets are actually opened in the stated time frame.

While there may be potentially less litigation risk to franchisors in making wildly optimistic predictions about system growth, their credibility is affected. Franchisors which are most keenly aware of this are those who are listed on the stock exchange, as optimistic predictions that do not turn into reality are usually met by a savage market response and a drop in share value.

An example of this is the halving of share value experienced by Collins Foods within weeks of its sharemarket debut in 2011 after the company issued a profit downgrade which contrasted severely with the expectations outlined in its original prospectus.

However, privately owned franchise groups (as the vast majority are) do not suffer the same immediate and quantifiable consequences of any bloated growth projections in this manner, and therefore are more likely to make them.

Instead, unlisted groups which fail to meet their optimistic growth targets suffer a loss of credibility and confidence among their various stakeholder communities, including existing and potential franchisees, suppliers, customers and others.

When this happens, it’s time to step back, consolidate and rebuild trust, before very cautiously exploring future growth opportunities.

But then again, those who are inclined to make wildly optimistic growth projections are unlikely to recognise the dangers of such blind optimism before the damage is done.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level.