“Diversify Your Risks; Look At Multiple Concepts”		«BACK
	by Dennis L. Monroe
	from Franchise Times, September 2002 Issue

What can we learn from mistakes made by franchisees when they diversified?

1. Some companies decided being a franchisee is not the optimal business structure and that owning concepts (and that is, a multi-group of concepts) is a more effective way to grow their business. Some of the companies using diversification (i.e., owning multiple concepts) have been so anxious or enamored with a concept that they have forgotten reasonable unit economics and paid too much for a concept that is unproven or has experienced limited success.

2. Some diversifiers under-estimated the cost of developing an acquired concept. A proven franchise concept has a definable cost of development. New concepts acquired under the guise of diversification can sometimes be so unproven that it is easy to under-estimate the costs.

3. In addition to under-estimating the development costs, some diversifiers under capitalized these concepts and consequently, were not able to take full advantage of the value of the concept.

4. A franchisee company's complete casting off of its franchisee relationships in an effort to acquire proprietary concepts can be a course of stark reality. A number of public companies attempted to do this and made a series of wrong moves. Although these companies were great franchisees, they were inexperienced in concept ownership. They also lacked the necessary capital and paid prices that were too high. All these factors created problems for the companies.

Owning a concept versus being a franchisee may be an absolute home run, but if the concept does not turn out to be portable, a too costly diversification project can be an albatross around the franchisee's neck.

Five basic tenets to glean from companies that had problems diversifying from a franchisee only company to a diverse franchisee concept owning company are:

1. The new concept needs dedicated management.

2. The new concept needs individual funding.

3. The new concept needs to stand on its own and not necessarily depend on other concepts for some type of synergy.

4. Effective firewalls need to be in place so if one concept has problems, these problems do not necessarily ruin the entire enterprise.

5. The new concept should be counter-cyclical with the existing concepts.

What should franchisees consider if they plan to diversify?

Do I Diversify Within the Same Industry? Successful diversifications all seem to result from diversification within the same industry (i.e., an auto aftermarket franchisee should continue to diversify in the auto aftermarket; a food service franchisee should continue to diversify in the food service industry; and a service oriented franchisee company should diversify in the service industry). In general, diversification should be within a known industry; however, diversification should not necessarily be in the same segment of that industry. Franchisees who operate quick serve restaurants may look to diversify into the casual dining segment. Even though casual dining is a slightly different sector of the marketplace, it is a segment that can be reasonably understood by a good QSR franchisee. Franchisees who are in the auto aftermarket or service oriented industries (such as quick lube) may want to look at the sale of products (such as tire sales). Again, this requires similar marketing and locations but is a diversification and allows for some insulation from focused competition.

Do I Diversify into My Own Concept or Another Franchise Concept? As reflected in the opening comments of this article, this may be the single biggest question to answer. Most franchisees do best when they diversify into other franchise concepts. This statement is based solely on my observation, and there are wonderful exceptions; but in most cases, people who have put together franchisee organizations are best to develop franchisee businesses. Concept ownership requires not only effective execution, but also constant evolution and reinvention. Most good franchisees are executors, not concept developers.

How Do I Fund The Acquisition Of Another Concept? It is too easy for franchisees who have decided to diversify to think they will use existing, well-performing assets to finance their diversification efforts. This is a big mistake. Different concepts require different types of funding. The operator should build separate businesses, with separate balance sheets, and appropriate firewalls between concepts. Also, different types of concepts can be leveraged to a different degree. A concept where real estate is owned and used can be leveraged to a higher degree than a pure leasehold interest.

How Do I Leverage My Existing Overhead? This may be one of the great benefits of diversification. When a strong franchisee has built a strong infrastructure, that infrastructure is a key asset. In most cases, the infrastructure can be transferred to a compatible, new concept. The controls and overall support provided by a successful franchisee are transferable to new segments of the management's expertise.

Do I Need Dedicated Management? Absolutely. Many diversification efforts have failed because of overlapping management. Bring fresh, experienced talent to any new concept. Make sure these managers are evaluated on the unique efforts for the concept, not overall company performance.

In summary:

o Diversification is good.

o Separate and dedicated management is a must.

o Separate capital structure is a key protection.

o Stay in the realm of your core competition.

o Tackle a common identity but in a different sector.

o Adequately fund the concept.

o Be patient - success does not come overnight.