“Retooling a Franchise System”		«BACK
	by Dennis L. Monroe
	from May 2004 Franchise Times

When there is a need to retool the system’s operations and increase consumer acceptance of products, financial engineering alone will not correct these problems. Many systems, as they mature, begin experiencing flat or declining sales. Initially this may be expected, but if this trend continues, profits will erode, less money will exist to invest in capital improvements, and the system will begin to spiral downward. Many times franchisors try to retool their systems by quickly introducing new products or implementing short term solutions. However, if a system is declining, it usually requires capital investment, face lifts or new looks that result in high consumer acceptance and appeal.

What can franchisors — in cooperation with its franchisees — do to retool their system?

• 1. Assess the Current Financial Situation. Franchisors and franchisees need to come together to assess the current financial situation of their franchisee community. Frequently, franchisors have unrealistic expectations of what their franchise community can do and thus, they impose upon franchisees requirements that are not financially feasible. Franchisors decide they need re-imaging or re-signage and then demand that franchisees make substantial expenditures to fulfill their requests, not knowing if the expenditures are viable. (Note: Most UFOCs require periodic updates of the image at the time of the franchisee’s renewal.)
• 2. Cooperate with Each Other. Franchisors and their franchisees need to cooperate regarding the changes necessary to turn their system around. The franchisee community needs to buy into these changes. An edict by the franchisor for certain changes — such as a new product line, new equipment or costly new in-store advertising — can result in non-compliance by the franchisees. It makes no difference what types of legal remedies exist; the franchise community must recognize that the best way to turn a system around is with voluntary cooperation from the franchisees.

• 3. Use Outside Experts. Both the franchisee community (through a franchisee advisory counsel) and the franchisor often bring in outside experts to look objectively at their system. These experts normally have a breadth of experience and the necessary impartiality to properly evaluate a system’s strengths and weaknesses.
• 4. Review, Compare, and Research Unit Economics. The franchise community needs to compare the unit economics currently in place with those in place at the time of the system’s best performance. Then they should carefully track the steps that were or were not taken that lowered the profitability and performance of the franchisee community. Further, it is important to complete a sensitivity analysis of the unit economics in the franchise community. The deviation of unit economics, the distribution of profitability among the various franchisees, and a comparison of the corporate stores’ profits to the franchisees’ profits should be reviewed. Finally, the franchise community should research what steps have been taken by the most profitable franchisees to keep their units viable.

• 5. Review the UFOC. The franchisor needs to review the UFOC to see if it still meets the needs of the system.
• 6. Assess Financial Capabilities. The financial capabilities of the franchise community must be assessed if significant capital expenditures are required. If a franchisee has the ability to make substantial investments in their stores (either through financing or through its own liquidity), the question is always one of a return on investment or assets.
• 7. Evaluate Profitability. The franchise industry has been slow in looking at ways to determine the success and profitability of a unit. In most cases, the franchise community has evaluated itself in terms of the cash flow of units and after reasonable G&A. Return on assets and/or investment, oftentimes neglected, is something that should be evaluated. It is difficult for a franchisor to insist its franchisees invest in their stores unless a substantial return on investment can be demonstrated.
• 8. Provide Proof to Franchisees. Franchisors need to put their money where their mouth is. They need to put their assets into their corporate stores to show the changes do indeed work. This should not be done on a limited basis. I remember a franchisor who built an opulent prototype store in Las Vegas. After experiencing tremendous sales, the franchisor expected other franchisees to follow. However, the prototype could not be effectively duplicated. A promising idea — without proof — will attract nothing more than dust.
• 9. Evaluate Expenditures and Return on Investment. Franchisors need to adequately evaluate their new generation of concepts and products, the capital expenditures necessary to grow, and the return on investment. These evaluations need to be done in diverse locations, and franchisors must be able to prove the business benefit to the franchisee.

• 10. Provide Appropriate Capital Investment. Significant capital investment is necessary to turn a system around. Franchisors cannot impose this cost upon their franchisees and must be willing to help those franchisees who are unable to locate financing for these capital expenditures. Over the years this column has addressed various types of franchisor-assisted financing (i.e., direct loans, guarantied loans, outside third party financing, and vendor-sponsored programs). Franchisors need to make careful assessments and then take the necessary steps to provide the appropriate resources to smaller operators within their systems.
• 11. Decide on System Size. To facilitate a system turnaround, franchisors need to decide on the desired system size. They must determine if they want a large or small number of franchisees. If they desire to reduce the number of franchisees, they must be able to facilitate an effective sale of the franchise businesses at reasonable prices to induce the smaller operators to sell. This may require incentives for the larger franchisors to complete a roll-up of the smaller franchisees.

I hope these ideas are helpful. Remember, there are many success stories in franchising. Though the situation is always exacerbated by multiple parties with differing financial capabilities, franchise systems can be turned around. The retooling of a system is one of the greatest opportunities when rethinking your franchising strategy. Just look at McDonalds.