A tough year ahead for franchise recruitment

For many franchisors, 2010 was a tough year for franchise recruitment, with network growth slowed or achieved through primarily granting additional outlets to existing franchisees.

Unfortunately, 2011 is shaping up to be an even tougher year for franchise recruitment, which has a flow-on effect not just for franchisors seeking growth in their networks, but also for existing franchisees who are looking to sell their businesses.

From the perspective of a potential franchisee, there are two interdependent factors that must exist before investing in a franchise (or any form of small business for that matter). These are capital and opportunity.

Capital

Few, if any, potential franchisees have unlimited financial means by which to invest in a business. This means that capital – or the ability to raise it – can be a major hurdle to any potential business buyer. In 2011, the following factors will play a greater role in restricting the amount of capital that business buyers will be able to raise.

Increasing cost of capital

Aside from any concerns about the availability of capital (see below), interest rates are virtually guaranteed to rise further during 2011, and this will increase the cost of borrowing money. Higher borrowing costs must inevitably lead to a higher performance of the business in which the funds are to be invested. If the business cannot operate at higher performance levels, the increased borrowing costs will eat into profits, reduce overall returns and diminish appeal among prospective buyers.

Securitisation issues

Since the global financial crisis, business owners have noted that lending institutions in general have increased their requirements for bricks and mortar security, and in some cases have changed these requirements in the middle of a loan term. Security changes mid-term often result in sending business owners into a tailspin to either come up with more security or rapidly find extra cash to reduce their loan balances to keep within the new security requirements.

Equity issues

The level of equity that business owners have in the properties offered as security (usually their homes) will become increasingly important in 2011 as property growth stalls and in some cases, property prices decrease rather than increase. Additionally, tens of thousands of home owners throughout Queensland, Victoria and other areas affected by flooding will face the real prospect of negative equity, or owing more against their house than the house is worth in today’s real estate market.

The creation of negative equity, plus the cost of rebuilding these homes (especially for those who did not have flood cover) will virtually eliminate the chances for these homeowners to raise the capital needed to buy a franchise.

Availability of capital

With the onset of natural disasters around the nation, available capital (as noted above) will be channelled toward rebuilding rather than new business ventures. This will reduce the amount of available capital for potential franchisees, which, coupled with higher borrowing costs, securitisation and equity issues will be expected to restrict the number of people with sufficient means to go into business for themselves.

Knowledge capital

Not knowing how to run a business has never prevented people from trying, especially when money is freely available. However, with an overall tightening of financial capital available for business investment, those who know what they are doing will have a competitive advantage over those who don’t. As a result, this knowledge capital – an understanding of the way business works and the specific market in which a business is to operate – will become more important.

Unlike the availability of financial capital, which can be increased or reduced according to market and other forces, knowledge capital is available for potential franchisees to acquire at almost any time. Learning about business can start with something as simple as reading books, talking with people, observation, and undertaking both formal and informal courses of study.

This can lead to better preparation and better application of whatever limited financial resources a business buyer has to invest.

Labour capital

At approximately 5%, Australia’s unemployment rate is technically that of a fully-employed nation. Even if someone goes into business for themselves, finding staff to work in it will be a challenge, and more so now with the huge workforce required to rebuild those parts of the nation which have been devastated by natural disasters. At the same time, international demand for Australian commodities remains high, creating a jobs boom for the mining sector.

The upshot of a continued mining boom and disaster rebuilding will be more work than people available, higher wages, and consequently, a reduction in the pool for both workers and potential franchisees for franchise networks. For potential franchisees, the prospect of ongoing high wages with job security, portability and benefits will outweigh many of the risks attached to self-employment for as long as the labour market remains tight.

Concurrently with the issue of capital, comes opportunity. While there is no shortage of franchise brands offering business opportunities in Australia (approximately 1,100 according to the 2010 Franchising Australia Survey conducted by Griffith University), opportunity refers to those circumstances which lead to people considering a franchise investment.

Opportunity

Opportunity comes in many forms, and varies from one individual to another. Some key elements that will determine opportunity for potential franchisees include the following:

Employment status

Linked closely with labour capital is the issue of employment status. During the early 90’s when unemployment in Australia was approaching 10%, many unemployed people turned to franchising as a form of self-employment. High levels of unemployment can stimulate franchise growth, however in the current full-employment environment this is unlikely.

Employment status not only refers to whether someone has a job, but whether they are satisfied in that job and if it is delivering them the income or recognition they require. With the growing trend in the employment of casual labour, workers whose employment hours do not achieve the income they require would seek alternative work before considering self-employment. Other workers may also seek a change of employer to improve promotion and earning prospects in a job-seekers market, rather than considering self-employment.

The franchise offer itself

With the high number of franchise systems in the Australian market, many business segments are highly competitive. Differences between brands at consumer level are one thing, but behind the scenes, differences in these brands for potential franchisees may be insignificant in terms of overall investment costs, ongoing royalties, operating systems, franchisor support and so on.

This means that not only should franchisors assess the competitive advantages of their franchise model, but should do so within the context of limitations to capital mentioned above. A number of systems which have already recognised this challenge to future growth have introduced vendor financing or work-to-own programs for potential franchisees, as well as created new franchise offers at different investment levels, improved business modelling to increase profits and offset capital costs, and so on.

Modifying the franchise offer itself is one thing franchisors can do to offset the effect of environmental changes to opportunities and capital available to potential franchisees.

Access to markets

Access to markets includes not just the availability of customers for a franchise’s products or services, but also the viability of accessing those customers. Many retailers are faced with spiralling increases in shop rents without a corresponding increase in sales, resulting in smaller margins and reduced profits.

Other types of businesses are challenged to establish sufficient demand (or properly managing demand) to maintain viable, long-term profits.

Opportunity cost

From a franchisee’s perspective, the opportunity cost in buying a franchise is the cost of some other course of action they could take instead. For example, the opportunity cost of leaving a job to buy a franchise is the cost of the future wage or salary foregone, as well as future potential for promotion, recognition, professional development, etc.

The opportunity cost of any business investment will be offset by the potential franchisee’s appetite for risk, financial capital, the franchise offer itself, and the other factors mentioned in this article.

This is not intended to be an exhaustive list of factors that will affect and potentially slow franchise network growth in 2011, but serves to highlight issues that potential franchisees and their professional advisors will be considering, and which franchisors should be thinking about in determining their growth targets.

At the end of the day, potential franchisees who have greater access to capital and opportunity will inevitably find their way to those franchisors who can demonstrate the best returns for capital invested, and best rewards for opportunities taken.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for nearly 20 years at franchisee, franchisor and advisor level. He advises both potential  and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.