75% of Franchisors Disappear Within 10 Years
Worldreview1989 - Several shocking facts once shook the franchise industry in the 2010s, including the following:
Within a period of 10 years, 75% of franchisors disappeared from the franchise industry.
Two relatively well-known franchise brands recorded SBA loan default rates of more than 35%.
Some lesser-known franchise brands in the United States recorded SBA loan default rates of approximately 60% to 80%.
75% disappear? What is really happening behind the franchise industry? Let us take a closer look at the following explanation.
Scott Shane, an American professor and researcher, once warned:
“Academic research shows that as many as three-quarters of new franchisors stop offering franchises after ten years in the franchise business.”
Nevertheless, the euphoria surrounding franchising and entrepreneurship has largely overshadowed this important information. The issue began to receive wider attention following concerns about the high rate of franchise-based SBA loan defaults.
Published information on SBA loans indicated that Subway had a default rate of only 4%, while Blimpie reached 37%. These figures were quickly questioned by observers, who asked whether the difference was purely related to the brands themselves or whether other factors were involved.
Although these percentages were calculated based on the number of locations belonging to the respective brands that had obtained SBA loans—not against the combined number of all franchise brands that had taken SBA loans, meaning they were not based on the total number of locations of those brands—the high percentages nevertheless challenge the assumption that franchises have a lower failure rate than independent, non-franchise businesses.
This is a disturbing fact, even though the data is limited to SBA loans in the United States. The franchise loan default rate during 2004–2006 was reportedly 10% higher than that of independent businesses (non-franchise businesses).
What about Indonesia? In Indonesia, there has still been no official publication or comprehensive official data on franchise loan default rates, either in the past or at present.
High-Risk Groups
Some observers suspect that the high SBA loan default rate among franchise businesses may be because many applicants for SBA financing are high-risk borrowers who were unable to obtain conventional loans from commercial banks.
If it is true that those who default are primarily high-risk borrowers, this may indicate weaknesses in the process used by franchisors to select prospective franchisees. This concern becomes even more significant when franchise businesses are found to have a higher failure rate than non-franchise businesses.
In Indonesia, there has been no official publication regarding franchise loan default rates. In 2011, the Indonesian government launched a low-interest financing program for franchise businesses through LPDB (the Revolving Fund Management Institution) under the Ministry of Cooperatives and Small and Medium Enterprises.
Hopefully, the program—which was intended to help reduce unemployment—was properly targeted, did not channel funds to incompetent franchise brands, and applied a strict selection process to prospective recipients so that the financing did not end up in the hands of high-risk groups.
At first glance, we can see quite a number of small cart-based businesses offered as business opportunities (BO) that eventually cease operations, even when the brands themselves are relatively well known. We have also witnessed several non-cart-based businesses operating under franchise brands that eventually closed, whether due to poor location choices, inadequate management, or other operational problems.
Franchisee Mismanagement
One factor that can contribute to franchisee failure is poor management.
Recently, I have encountered quite a number of franchisors who have struggled with franchisees who lack discipline in managing their business finances.
For example, one retail franchisee took out a car loan with monthly installments of approximately IDR 5 million when the business had just begun generating monthly net cash flow of around IDR 5 million. As a result, whenever the business failed to generate net cash flow of Rp5 million, its ability to maintain sufficient inventory was affected. This caused both sales revenue and net cash flow to continue declining.
There are also retail franchisees who lose sight of the significance of the cash generated from their retail sales. They use a large portion of the sales proceeds for personal expenses, even though they should have set aside sufficient working capital to purchase new inventory and replenish their stock.
Given the significant risk posed by poor financial management, franchisors whose franchisees receive capital assistance through LPDB financing are strongly advised to closely monitor the franchisees' financial management during the first three years. This approach can help ensure that the financing is managed responsibly and improve the likelihood of successful loan repayment.
Franchisor Management Competence
Some parties argue that the high default rate in the United States was caused by the economic recession that hit the country. Nevertheless, SBA loan data reportedly provides two versions of franchise loan repayment reports: the “Top 100 Best Franchise Brands” and the “Top 100 Worst Franchise Brands.” This suggests that franchise loan defaults are not simply the result of an economic recession, but may also reflect the management competence of the franchisor and the franchisee involved.
Difficult times have been experienced by almost every business at some point. McDonald's, for example, faced serious and critical challenges around 2002. Larry Light, a consultant and former Chief Marketing Officer of McDonald's, revealed that when he joined the company in September 2002, McDonald's stock price had fallen from a high of $45.31 in March 1999 to $17.66. The stock price continued to decline, reaching approximately $13 in March 2003.
McDonald's successfully overcame this critical period. Its stock price surged from approximately $13 in 2003 to around $32 by the end of 2005. During the January–May 2011 period, McDonald's stock traded above $70. From mid-May through early June, the stock price even remained above $80.
Owner-Operator Model
In general, according to Scott Shane, new franchisors that require franchisees to operate as 100% owner-operators tend to have significantly lower failure rates than franchises operated by passive investors.
The success of the owner-operator model, however, depends heavily on a rigorous franchisee selection process. If an individual who lacks the necessary skills to manage the business passes the selection process, the outcome can be the opposite: a disaster for that franchisee's outlet and potentially for the entire franchise network if the mistakes affect customer satisfaction and damage the franchise brand's reputation.
Imagine a restaurant called “Bakso XYZ.” A customer visits the restaurant for the first time. He complains to the manager, who happens to be the franchisee and owner-operator, saying, “The broth contains too much pepper.”
The owner-operator casually responds, “That's how the standard recipe is supposed to be.”
The customer immediately develops the perception that “Bakso XYZ” does not serve meatballs that suit his taste. Most likely, he will not want to visit another “Bakso XYZ” outlet in a different location.
This simple example illustrates how the competence and attitude of an owner-operator can directly influence customer satisfaction and, ultimately, the reputation of the entire franchise brand. A single negative customer experience may not only cause the loss of one customer but can also shape the customer's perception of the brand as a whole.
About the Author
David Mulyana is the founder and editor of WorldReview1989, an independent publication dedicated to finance, investing, insurance, business, technology, and digital marketing.
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